Why retail investors should tread IPO market with extra caution

More recently, Lenskart’s IPO was in the news for its IPO at ₹70,000 crore-valuation, which was roughly ten times its sales and 230 times its FY25 earnings.

Unfazed by such high valuations, retail investors lapped up the shares of the eyewear retailer, with the retail book getting subscribed 7.56-times. The appetite of retail investors for IPOs has remained strong, with the average subscription of retail book being about 24.28-times in 2025.

Such an appetite doesn't, however, take away from the fact that IPO investing comes with its own set of risks. An issuer's valuations, for instance, may not align with how the market prices it after listing. Nearly two-fifths of IPOs between 2021 and 2025, for instance, are trading at below issue price, data from Prime Database shows.

Key risks may remain unclear as the firm’s disclosure cycle has only just begun.

Thus, retail investors need to tread IPO market with utmost care. Here is how you can use the company’s disclosures to take a more calculated risk when betting on an IPO.

What to look for

Experts say retail investors should begin by examining the basics — valuation and business maturity. Deepak Jasani, an independent market expert, says most retail investors neither have the time nor the expertise to decode a company’s draft prospectus in depth. “Start with simple metrics such as the price-to-earnings (P/E) and price-to-book (P/B) ratios and compare them with listed peers in the same industry. Metrics such as EV/Ebitda are slightly more complicated. Investors can find details of comparable peers in the company’s red herring prospectus (RHP)," he advises.

The RHP is required to be made publicly available. But there is a caveat here, the RHP may compare the company with highly-valued peers. So, investors should also try and dig around on their own to see how other peers are valued.

For loss-making companies, traditional valuation metrics don’t work because earnings are negative. In such cases, analysts often turn to the EV/EBITDA multiple, as it focuses on a company’s operating performance (earnings before accounting for interest, taxes, depreciation, and amortisation). This helps gauge the business’s underlying earning potential, even when net profits are yet to materialise. EV stands for enterprise value, which represents a company’s total value — including its market capitalization, debt, and minority interest, minus cash and cash equivalents.

Jasani adds that retail investors should rather be conservative when looking at IPOs even if it means missing out on some opportunities. “Look for businesses with strong fundamentals. Check whether the business has a dividend distribution policy. The track-record of dividends means that the company has gone over its big investment phase and the company can now partly share its profits with shareholders. Looking for dividend-paying companies would automatically mean that all the loss-making companies that come for IPO would be ruled out," he explained.

He maintains that if investors are unsure about their due diligence, it’s better to wait until the company lists and observe its performance for a few quarters – assessing whether the business is delivering as promised and how management commentary evolves – and then whether to buy the stock or not.

Flipping behaviour

Retail investors are often looking at IPOs just for the day listing gains and not so much for the company’s long-term potential. A study by Securities and Exchange Board of India (Sebi), found that 54% of IPO shares allotted (in value terms) to investors on an average – excluding anchor investors – were sold within a week. The study analysed IPOs between April 2021 and December 2023. In the same period, retail investors sold 42.7% of shares allotted to them within a week.

Exits were higher in companies where the returns were high in first week of listing. When returns were more than 20%, retail investors exited 61.9% (compared to average of 42.7%) of shares allotted within the first week of listing.

According to G Chokkalingam, founder and head of research at Equinomics Research, investors just looking for listing gains, should still take certain precautions. “You may be keen to invest in IPO of a company, despite its steep valuations, but then limit your exposure. If the business is listing at discount to its IPO prices, cut losses immediately. If there is a listing day gain, quickly book profits. Once the company lists and the initial excitement settles down, markets start to price the business more efficiently on the basis of the business fundamentals."

“We need to acknowledge that retail investors are inherently attracted to IPOs. Having said that, they should be clear about their strategy. Are they coming for listing gains or as a long term investment? If coming in only for listing pop, they should also exit in case the issue lists at a discount," said Pranav Haldea, managing director of Prime Database.

The same Sebi study showed that individual investors were not as quick to cut losses when gains disappointed. Individual investors exited only 23.3% of allotted shares when returns were negative in first week of listing.

This is one of the reasons why investing in IPOs for quick gains, which is what most retail investors seek, is not recommended. An IPO with lot of euphoria may still list at steep discount and potentially see huge downside when investors panic and sell.

Reading the RHP

As mentioned earlier, RHP can give lot of clues about the company’s business operations.

You can go through various sections of the RHP. Start with the ‘About our company’ section. “This will help you learn about the company’s business model—what products or services it sells, who its customers are, and how it plans to grow. Check if the company operates in a fast-growing industry and whether it has something unique or is just another player in a crowded market," said Pankaj Pandey, head-retail research at ICICI Direct.

“Get a sense of the size of the industry, growth runway. Look for the company’s market share, brand strength, technology edge, regulatory licenses, distribution network, or cost advantage that competitors cannot easily replicate," he added.

This is also the section where you can see the company’s dividend policy.

Next, check the company’s ‘Financial information’. “Look for steady revenue and profit growth over the past few years. Commentary on expansion plans—capacity additions, new geographies, product launches, customer acquisition strategy. Consistent revenue growth, improving profit margins, and strong cash flows are good signs," he added.

Also, look out for these red-flags. “If the company shows profits on paper but negative cash flows year after year, that’s a red flag. Similarly, a highly leveraged balance sheet or frequent refinancing of loans could mean underlying stress," Pandey explained.

Over-dependence on one or two customers or suppliers is also a cause of concern.

“Pay attention to governance and promoter quality. The RHP discloses information about the promoters, their track record, related-party transactions, and any pending litigations. Promoters with a history of frequent business changes or large related-party dealings should make investors cautious. Are there any auditor remarks, suggesting weak internal controls…," he said.

Further, check how the company plans to use the IPO proceeds. Raising funds to expand capacity or reduce debt is healthy; using it to allow existing investors to exit entirely could be a concern.

What should investors do

If directly investing in stocks is risky, unless you are well-versed in stock research, investing in IPOs is even riskier because the company’s disclosures are limited. Current regulations require companies to disclose just three years of financial statements. Mutual funds are one option where investors can get exposure to IPOs in an indirect manner.

Fund managers often make allocation in the anchor book of the IPOs and have the capacity to research and track the company’s future performance.

Bharat Lahoti, co-head, factor investing, Edelweiss Mutual Fund, who runs the Edelweiss Recently Listed IPO Fund, says the fund continuously tracks newly listed companies and reassesses them after listing. “We exit or trim holdings if the company doesn’t walk the talk, shifts into unrelated businesses, or if valuations become unrealistic," he explains. Sector-specific headwinds or governance concerns can also trigger an exit.

He adds that short-term earnings disappointments aren’t always a reason to sell. “If growth is merely delayed, we stay patient. But if execution falters, we pull out early," says Lahoti.

Additionally, investors must check their own risk-profile before considering any fund.

According to Vishal Dhawan, founder of Plan Ahead Investment Advisors, “When clients come to us seeking advice on investing an IPO, we educate them about the risks of investing in an IPO for short-term gains, risk of investing in high-valued IPOs, especially where promoters are exiting. If there are large IPOs, which they wish to consider, we share with them our long-term view on the company to help them make an informed decision," he said.

However, investing and researching for an IPO is like a maze as there are many factors that could impact how the IPO performs after listing, which may be difficult for retail investors to decode. The best approach for retail investors, then, is through a diversified mutual fund that may also participate in select IPOs.