Six IPOs are all set to hit the markets in April. With the bourses operating close to their lifetime highs, companies are making a beeline for the primary market.

Since the lows in March last year, the markets have zoomed up to near-stratospheric levels giving handsome returns to value investors. Several factors have been powering this leap. Primarily, the robust upward movement comes on the back of a new community of young millennial traders who are now becoming a new force to be reckoned with in the secondary markets. While some of them are in it to earn passive income on the side, many of them are looking to become full-fledged stock market traders and investors.

Secondly, the RBI has been cutting back on interest rates aiming to revive animal spirits in the economy at a time when business sentiment and economic activity on whole is haemorrhaging thanks to the pandemic. This coupled with the fact that the Federal Reserve in the USA has also been cutting rates which has led to several FIIs looking for new shores to invest in. Evidently, India, as a developing market has been luring them in by the droves and the easy liquidity being pumped in by the FIIs has led to an inflated valuation of not just blue-chip firms but also of mid and small-cap companies.

These three factors working together have led to an IPO rush. Several retail investors tend to go agog over investing in IPOs given the tempting returns one can stand to earn in the case of a company that has great fundamentals. However, this does not mean that the IPO of every run-of-the-mill company delivers massive returns. Many naive retail investors fall for this myth and rue the loss of their savings subsequently.

The situation in the IPO market has changed drastically from the simplistic scenario that prevailed at one point in time in the early 90s. Issues then used to be priced in the ballpark range of Rs 10 to Rs 30 and the premium that one could earn from the listing of the shares did not exceed three times the face value. Additionally, one could suss out the enthusiasm for the IPO by looking at the queues at the banks around the BSE building.

However, things- thankfully- have advanced by leaps and bounds, and an intricate and robust digital infrastructure has ensured that investors from villages and tier 2 and tier 3 towns can also apply for subscriptions. While enthusiasm for IPOs has percolated to ground zero, a healthy scepticism about IPOs hasn’t. IPO investments are still heralded by fervent word-of-mouth publicity among investors rather than a critical look at the fine print of the issue offer and a deep scan of the company concerned.

This is why it becomes all the more important for people looking to put their savings in IPOs to educate themselves about the myths surrounding IPOs.

IPOs give you the best valuations

IPOs often debut during bullish market phases to ensure that they see the highest participation, both institutional as well as retail. Positive market sentiment often pushes up the valuations of the listed shares. However, this does not mean that the valuation by the market is apt. In fact, shares of many companies have been listed at a premium on the first day only to be available for cheap later once the initial investor frenzy subsides. Just because a company is launching an IPO doesn’t mean that the allotted shares will be available for cheap. There are numerous instances of shares collapsing once they are listed. Even otherwise, retail investors will do well to remember that they come pretty much last in the queue. Private equity firms, angel investors and venture capitalists are wooed by the company early in the game.

Retail investors must take advice from financial experts and market experts to assess if they should or should not invest in the IPO of a company. The focus should be on the fundamentals of the company and not the short term gain.

The quick gains trap

Many investors apply for allotment of shares as they wish to make a quick buck on the listing of the shares in the secondary markets. Fundamentals are often relegated to the side during an IPO investment. Experts state that statistically speaking close to 80% of the IPOs fail, and outperformers come once in a while.

An over-subscription of an IPO is not evidence of the financial health of the company. Over-subscription suggests that the IPO is popular with the public at large, however, this in itself is no guarantee that the company will continue to perform brilliantly in the long run.

Remember that during a bull market, companies with weak fundamentals also get over-subscribed.

The share price will not slip below the issue price

This is as big and naive a myth as it comes. There is no guarantee that the listed shares will not slip below the issue price. Consider the case of a major power company which was listed on the bourses in February 2008. There was a feverish excitement in the market for the IPO and the company had collected over Rs 11,000 crore from subscribers. The IPO had been oversubscribed 72 times and had received bids over Rs 7 lakh for its shares. The company had fixed the share price for retail investors at Rs 430 and for institutional investors at Rs 450. Within five minutes of the shares being listed, the scrip touched a high of Rs 538 only to plummet to Rs 350 and close at Rs 372.

The few minutes for which it traded above Rs 430 was the only time when it was operating above the issue price to date. In January 2018, it was trading at Rs 58. Currently, it trades at Rs 6.75.

Bottom line

Instead of rushing in for an IPO investment in hopes of earning a quick buck, investors should reassess their investment philosophies and focus on collecting shares of companies with sound financials and long-term growth prospects. IPOs are often a gamble, and even those IPOs which are largely touted to be immensely successful can suddenly nosedive.