Expert view: IPOs that primarily provide liquidity to early investors can be a red flag, says Sarvjeet Singh of Shoonya

Expert view: Amid the current IPO frenzy, Sarvjeet Singh Virk, the Co-founder & MD of Shoonya by Finvasia, had an exclusive conversation with livemint regarding the substantial increase in IPOs, the best time frame for investing in an IPO, the risks of having a short-term perspective on IPOs, the necessary research that investors should conduct before investing in an IPO, and the common mistakes that retail investors should steer clear of when investing in an IPO.

Edited excerpts:

What are key triggers that will influence the stock markets in September? What should investors be aware of?

Domestically, the progress of the monsoon, corporate earnings, inflation data, and RBI monetary policy decisions will play crucial roles. Globally, the US Federal Reserve's decision on interest rates, geopolitical tensions (like Russia-Ukraine, Israel-Palestine wars), crude oil prices, and global economic indicators will also impact market sentiment. Additionally, a potential increase in IPO activity could further influence the market, as new listings can generate excitement and attract investor interest.

It's important to note that these are just a few of the factors that could influence the Indian stock market in September. The market can be volatile, and unexpected events can occur. Investors should stay informed about these factors and conduct thorough research before making any investment decisions.

2024 and September particularly has witnessed a significant surge in IPOs, what’s behind this rise?

India's robust economic growth, driven by government reforms and increased consumption, has made it an attractive market for investors. Lower interest rates, thanks to the accommodative monetary policy of the Reserve Bank of India, have reduced the cost of capital for companies, making IPOs a more appealing option. Government initiatives to improve the ease of doing business and tax incentives have further encouraged companies to list on Indian exchanges.

Growing awareness of the stock market and increased participation by retail investors have driven demand for IPOs. The Demat Accounts in India rose by over 4.23 million in August rising to 171.1 million, reflecting this prominent change. Positive market sentiment and expectations of strong returns have motivated companies to capitalise on favourable conditions. Technological advancements have made the IPO process more efficient and accessible, reducing costs and speeding up the timeline for companies going public.

The surge in IPOs has been particularly pronounced in high-growth sectors like technology, healthcare, and consumer goods. The listing of several unicorns, or privately held companies valued at over $1 billion, has generated significant buzz and attracted investor attention. These factors have combined to create a positive climate for IPOs in India, leading to the significant increase witnessed in 2024, particularly during September. However, it's important to note that the market can be volatile, and investor sentiment can change rapidly.

What are some of the risks of having a short-term outlook towards IPOs?

Retail traders tend to seek immediate returns. Additionally, they often have limited knowledge about when the market rally might conclude. Many IPOs are priced based on optimistic projections rather than solid financial performance. This can lead to situations where shares are overvalued at the time of listing. The performance of newly listed shares can be heavily influenced by prevailing market sentiment. Investors who focus on short-term gains may find themselves exposed to substantial losses if they sell during a downturn or fail to anticipate market corrections. Therefore, retail investors are more inclined to take immediate returns.

What should be the ideal time horizon when investing in an IPO?

When investing in an IPO, the ideal holding period depends on investors’ risk tolerance and investment goals. During an overvalued, uncorrected, or unpredictable market, it is better to lock in profits. There are no hard and fast rules for the investment horizon when investing in an IPO. It totally depends on the investor's decision. The more confident and seasoned investor may hold the investment for the long term at their discretion.

What kind of due diligence should investors do before investing in an IPO?

The complexity of IPOs often makes it challenging for retail investors to conduct thorough due diligence. While retail investors can review the prospectus and analyse financial metrics, the intricacies of financial statements, legal documentation, and regulatory filings can be overwhelming for those without a strong financial background.

When evaluating an IPO, retail investors should prioritise understanding the company's fundraising purpose. If the funds are intended for business expansion, accessing additional capital, investing in research and development, marketing, or paying off existing debts, it can be considered a reasonable use of proceeds. However, IPOs that primarily provide liquidity to early investors, such as through an Offer for Sale (OFS), can be a red flag if the company doesn't focus on these expansion factors.

Additionally, investors should carefully read the prospectus to understand the company's revenue generation, market positioning, competitive advantages, and growth potential. Identifying key competitors and assessing the company's market share, strengths, and weaknesses relative to them is crucial. Understanding the competitive dynamics can provide insights into future growth prospects. The prospectus is a critical document that provides essential information about the company, including its financials, business model, and risks. Investors should read it carefully to fully understand the offering.

Are there any mistakes that retail investors should avoid when investing in an IPO? And any advice regarding them.

With the growing IPO frenzy, retail investors are often following friends' and colleagues’ advice to invest in IPOs. IPO investments require expertise and knowledge of the industry and the market as a whole. This is where many are going wrong and end up losing money. Always consider your own investment goals, budget, and investment tenure before investing in IPOs again.

Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decision.