In a hyped-up IPO market, what is the best way to play the game in 2025?

Long-term investors should only invest in an IPO when the company's fundamentals are strong and valuations reasonable

India emerged as the global leader in terms of the number of initial public offerings (IPOs) in 2024, according to a recent report by the Pantomath Group, a leading financial services conglomerate. It hosted twice as many IPOs as the United States and two-and-a-half times the number in Europe. Altogether, 76 Indian companies raised Rs 1.3 trillion through the IPO route in the first 11 months of 2024. Investors planning to invest in IPOs in 2025 should be cognisant of both the risks and the opportunities.

 

Key risks in IPOs

 

In 2024, IPOs received an overwhelming response. Altogether, 72 out of 92 IPOs received over Rs 10,000 crore in subscriptions. This had consequences for retail investors. “It often led to IPOs coming at inflated valuations,” says Yash Sedani, assistant vice president, investment strategy, 1 Finance. 

In an IPO, only limited information is available to the investor about a  company’s historical performance. Companies are required by the regulator to disclose only three years of financial performance. Most companies come to the market when their recent performance is looking good. In contrast, in a company that has been listed on the markets for a long time, investors have the opportunity to judge its performance across business cycles. 

A lack of knowledge about the antecedents of many of the promoters adds to the risk of investing in IPOs. “This is especially an issue in SME (Small and Medium Enterprise) IPOs,” says Sunil Subramaniam, market expert and chief executive officer, Sense and Simplicity, a financial literacy venture. 

Market sentiment is a key unknown in IPOs. Between the filing of the prospectus and launch of the IPO, market sentiment can turn adverse, resulting in a poor response to even a good-quality company. However, this is a negative development only for speculators, who could be deprived of listing gains. For long-term investors, this may work in their favour as they could get a good allotment or to buy shares at a better price (if promoters revise the price downward so that the IPO goes through).

 

When is it okay to invest?

 

In some circumstances, it is okay for long-term investors to go for an IPO. 

One is when a company has a new business model and has no listed peers. It could be an opportunity to include a new type of stock in the portfolio and diversify it further. 

Another is when the company has strong fundamentals. “It is advisable to invest in IPOs of entities that have exhibited a good track record and have excellent potential for future growth and sufficient profitability to share with the new investors,” says Jyoti Prakash Gadia, managing director, Resurfent India, a Sebi-registered category one merchant bank. 

According to Sedani, it is okay to invest in an IPO when the company operates in a promising industry. He also urges investors to check the purpose for which the money is being raised. “The IPO proceeds should be utilised to fund business expansion,” he says. 

In other words, the IPO money should not just be used to offer an exit to promoters. “If the promoter is cashing out, it is a sign he does not have much confidence in the business,” says Subramaniam.   

Gadia adds that it is okay to invest when the promoters come with a lot of experience, and both the competitive landscape and regulatory environment are favourable for the company.

 

Mistakes to avoid

 

Investors should avoid investing in an IPO based only on hype. 

“Some unscrupulous promoters paint a very bright picture of growth potential and future earnings. They create high expectations about market share and market capitalisation. Common investors tend to fall prey to such projections and put in their hard-earned money. False stories of quickly doubling your money need to be avoided,” says Gadia. 

Investors must not put in money without first doing adequate research. “Understand the company’s fundamentals and assess its valuations,” says Trivesh D, chief operating officer, Tradejini. Investing at inflated valuations can lead to losses. He also warns against overexposing one’s portfolio to IPOs. 

Investors should also be highly wary of investing in IPOs of companies in cyclical sectors. “The promoter displays the recent good performance and encashes his holdings at a high valuation. In the years that follow, the company’s performance goes downhill and investors have to bear the brunt of the down cycle,” says Subramaniam. 

Investors should also be highly cautious when sentiment is bullish and market valuations are high. Subramaniam suggests not investing in such an environment. “Markets go through cycles. Even stocks of good companies will be available at a discount at a later stage in the secondary market,” he says. 

Investors (as opposed to speculators) should avoid chasing listing gains. “Listing gains are not guaranteed and funds can get stuck if expectations are not met,” says Trivesh. 

When to invest in an IPO?

• Invest when the company has a new business model with no listed peers, offering portfolio diversification
• Go for a company that has a solid track record of profitability, and excellent growth potential
• Prioritise IPOs of companies operating in promising industries
• Ensure the IPO proceeds are being used for business expansion, not just to offer an exit to promoters
• Invest when the promoters have significant experience, and the competitive landscape and regulatory environment are favourable

 

When not to invest?

• Avoid IPOs promoted with exaggerated growth and earnings projections
• Avoid investing at high valuations in highly bullish markets
• Be cautious of IPOs in cyclical sectors where promoters may capitalise on current good performance

(The writer is a Mumbai-based independent financial journalist)