How to Earn by Investing in IPOs

The main goal of investing in an IPO is to profit by selling shares when their price increases. This can happen in two ways:

1. Listing Gain

Many investors apply for an IPO solely to make a profit on the listing day. When a company’s shares are first listed on the stock exchange, if their price is higher than the issue price (the price at which shares are offered in the IPO), then that additional amount is the listing gain. For example, if a company’s share is issued at ₹100 in an IPO and opens at ₹120 on the listing day, then the listing gain is ₹20. For this type of gain, many people sell their shares on the very day of listing.

What to look for Listing Gain:

Company Fundamentals: Analyze the company’s business, management, and financial health (e.g., revenue, profit, debt) thoroughly. Companies with strong fundamentals have a higher probability of listing gains.

GMP (Grey Market Premium): Although GMP is an unofficial indicator, it gives an idea of the potential share price in the market before the IPO listing. The higher the GMP, the higher the perceived chance of listing gains. However, GMP may not always be accurate.

Market Sentiment: When the overall market conditions are good (a bullish market), investors show more interest in IPOs, and the chances of listing gains increase.

Subscription Status: If an IPO is heavily oversubscribed (especially in the retail and HNI categories), it indicates high demand for the shares among investors. This increases the likelihood of listing gains.

Issue Pricing: If the company’s shares are offered at a fair price or with a slight discount, there’s an opportunity for listing gains. If the price seems excessively high, there might be no listing gain, or even a listing discount.

2. Long-term Investment

Some investors invest in IPOs, not for listing gains, but by relying on the company’s long-term growth. Their aim is that the company will grow larger in the future, and its share price will increase, leading to significant long-term profits.

What to look for for Long-term Investment:

Company’s Business Model: Understand how the company earns money, how sustainable its business model is, and its future potential.

Growth Potential: Look at the sector in which the company operates and its future growth prospects. Analyze how strong the company’s own growth plans are (e.g., new products, market expansion).

Management Team: The experience, expertise, and track record of the company’s management are very important. A strong and honest management team contributes to the company’s growth.

Competition: Identify the company’s competitors in that sector and understand its competitive advantages.

Financial Health: Thoroughly review the company’s financial statements (e.g., balance sheet, profit and loss statement). This will give you an idea of the company’s revenue, profit, debt, and cash flow.

Purpose of IPO: What will the company use the money raised from the IPO for? If it’s for constructive purposes like business expansion, new projects, or debt repayment, it’s a good sign.

How to Invest in IPOs (General Procedure):

Demat and Trading Account: Open a Demat and trading account with any stockbroker. This is mandatory for applying in an IPO.

Research: Conduct thorough research on the IPO you wish to apply for. Read the company’s Red Herring Prospectus (RHP) carefully. Check research reports from various financial portals and brokerage houses.

Apply: You can apply for an IPO through your Demat account or using the ASBA (Application Supported by Blocked Amount) facility provided by your bank.

Bid at Cut-off Price: For book-built IPOs, it’s generally advised to bid at the cut-off price to increase the chances of share allotment.

Multiple Demat Accounts: If different family members have separate PAN cards and Demat accounts, you can apply from multiple accounts to increase your chances of allotment. (However, do not apply multiple times from a single PAN; it will be rejected).

Check Allotment: After the IPO closes, you can check your allotment status on the registrar’s and stock exchange’s websites.

Monitor on Listing Day: If shares are allotted, keep an eye on the share’s performance on the listing day. Make a decision based on your investment objective (listing gain or long-term).

Risks:

Investing in IPOs can be profitable, but it also carries risks. Often, IPOs are issued at an inflated price, or the price might fall after listing if the market is unfavorable. Therefore, always invest according to your risk appetite and try to diversify your portfolio instead of investing all your money in a single IPO.

What Are the Risks Involved in IPO Investment?

Risks in IPO Investment

Investing in an Initial Public Offering (IPO) comes with several risks. Here are the main ones explained in detail:

1. Overvaluation

This is one of the biggest risks in IPO investing. Often, companies and investment banks set the IPO share price too high, driven by market hype or an overestimation of future performance. When the actual market demand and the company’s true financial health become apparent after listing, the share price may fall. This means the shares might start trading at a price lower than what you paid, leading to a listing loss instead of a listing gain.

2. Lack of Historical Data

Since a company goes public for the first time through an IPO, it lacks any public trading history. Investors don’t have long-term data on the company’s performance, profits, or losses. This makes it difficult to accurately estimate the company’s future performance and growth potential. Unlike established public companies, where years of financial data and market behavior can be analyzed, this isn’t possible for IPOs.

3. Market Volatility

Share prices can experience sharp fluctuations during and immediately after an IPO listing. The overall market sentiment (whether bullish or bearish) significantly impacts IPO performance. If the market is volatile or performing poorly at the time of listing, even a good company’s IPO might not meet expectations. Sudden large-scale selling (panic selling) or a decline in investor interest can cause share prices to drop rapidly.

4. No Guarantee of Allotment

There’s no guarantee that you will receive shares even if you apply for an IPO. Especially if an IPO is oversubscribed, the chances for retail investors to get shares significantly decrease. Often, shares are distributed through a lottery system. As a result, your application might not be successful, even though you might have waited with the hope of getting shares.

5. Liquidity Risk (Especially for SME IPOs)

Some IPOs, particularly those listed on SME (Small and Medium Enterprises) platforms, might have very low trading volumes after listing. This means that when you want to sell your shares, you might not find enough buyers, or it might be difficult to sell at your desired price. This issue usually doesn’t affect shares of large and established companies, as they have plenty of buyers and sellers in the market.

6. Market Hype and Misleading Promotions

Many IPOs are surrounded by extensive media coverage and promotions, which create exaggerated expectations among investors. Due to this hype, many people invest without adequate research, solely in the hope of quick profits. However, this promotion doesn’t always reflect the company’s true value or potential. Once the hype subsides, the share price can correct rapidly.

7. Competitive and Industry Risks

The company launching the IPO might operate in a highly competitive industry. If the company lacks a sustainable competitive advantage over its rivals, it can be challenging to maintain long-term growth. Overall industry challenges or regulatory changes can also negatively impact the company’s business.

8. Lock-up Periods and Insider Selling

After an IPO, there’s a specific period (e.g., 30 days, 90 days, or longer) during which the company’s promoters, insiders, and anchor investors are restricted from selling their shares. This period is called the “lock-up period.” When this lock-up period ends, these large investors might start selling their shares. A sudden increase in the supply of shares in the market can put negative pressure on the price.

9. Long-Term Underperformance

Many studies have shown that while some IPOs deliver listing gains, they may underperform compared to other established stocks in the market or their own sector in the long run. This can happen due to company management, business strategy, or changes in market conditions.

How to Mitigate Risks:

In-depth Research: Before applying for an IPO, thoroughly read the company’s DRHP (Draft Red Herring Prospectus). Get detailed information about the company’s business, financial health, management, debt levels, and the purpose of the IPO.
Don’t Rely Solely on GMP: GMP is merely an indicator; it doesn’t provide legal or guaranteed information. Therefore, don’t make investment decisions based solely on GMP.
Understand Market Sentiment and Valuation: Try to understand the overall market trend. Evaluate how the company’s valuation compares to its peers. If the price seems excessively high, refrain from investing.
Long-Term Perspective: Instead of investing solely for listing gains, analyze whether the company has long-term growth potential.
Diversification of Investments: Try to mitigate risk by investing in various sectors and companies, rather than concentrating all your investments in a single IPO.

While IPO investments offer the potential for high returns, they also come with a high degree of risk. Therefore, it is crucial to make decisions calmly, with adequate research, and by understanding your own risk tolerance.

How to Earn Money by Investing in IPOs?