In this article, you will see why there is a preference for IPO and why it gets oversubscribed. You will also see what you should be doing before you invest in an IPO.
Table of contents
- How do IPO’s get oversubscribed?
- Do investing in IPO always give you high profits?
- How to avoid this?
- So what you should be doing?
“If you can get an IPO, don’t buy it. Only buy IPOs you can’t get”. – Vahan Janjigian
How do IPO’s get oversubscribed?
The process of buying shares in an IPO becomes a kind of lottery.
If you invest in a startup and it sells innovative technology and If it manages to stay in the market then it may earn huge profits in a short period. If the company is good and there is demand, many would want the shares of that company and hence the supply becomes limited. So the demand exceeds the supply and hence artificial scarcity gets created. This is how the shares of a particular company get oversubscribed.
So it is perceived to make faster profits if you are lucky with the allotment. This is why it is said to have a lottery element. But never invest, for this reason, that is, “to make quick profits”.
An important key to investing is to remember that stocks are not lottery tickets. – Peter Lynch
Do investing in IPO always give you high profits?
Not at all. Some investors have been lucky and have got high profits through the rising value of the shares, it doesn’t mean everyone will make profits, every time.
It is created in the investor’s mind that if they invest in IPOs they get huge profits in a short time. A stock’s price can also drop soon after the IPO, resulting in huge losses for the investors.
One of those similar incidents took place in 2008 when Reliance Power IPO had launched. This was a “HUGE IPO” that so many people wanted to get into this IPO. There was a lot of hype created around this IPO that rickshaw drivers, milkmen were wanting to open a Demat account just to invest in this IPO.
That was the craze behind this IPO.
The issue price was Rs. 450 and on the listing day, only for the first 4 minutes, the stock was trading above the issue price.
What happened next?
People invested in this stock. The same day the stock finally closed at Rs. 372.50. Then Anil Ambani announced some bonuses which brought the price to about Rs. 281.
After that, 12 years have passed, the stock price has never gone beyond that issue price and you will not believe, there are a lot of investors still holding Reliance Power in their portfolio.
Do you know at what price the stock is trading now?
At Rs.3 in Dec 2020.
Imagine…….Rs. 450 shares trading at Rs.3.
This was just to let you know that IPO’s can also result in massive losses and holding on to such loss-making investments doesn’t really help!
How to avoid this?
There is a lot of hype that surrounds IPOs. The hype is making quick profits, which doesn’t always happen.
So what should you be doing?
Don’t you want to know about the company before you invest in it?
What you have to do is to check how good the fundamentals of the company are for its valuation. Select a company and read its prospectus. Be an informed investor and this will help you make a better decision.
So what are the things that you have to check before you invest in a company’s IPO?
- Relative strength in the industry
- Dividend payout
- The market for the product/service
- Management team
- Growth opportunity
- Financial performance
- Company’s track record
- Risk factors
After finding out these, if you like the company and are interested to hold its stock for a long period, then you can go ahead and invest, otherwise, don’t invest in it. Holding it for a longer period can help earn huge returns. The corpus earned can help you reach your long-term financial goals like retirement. Hence you should invest it for a longer period.
So always remember before investing in an IPO, you are not doing it for the sake of the lottery element but for holding it for a longer period.
“It is waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you have got to work very hard to overcome that.”-Charlie Munger
Now you get a bonus link to “factors to be considered before investing in an IPO.”