Investing in the Initial Public Offering can be highly profitable if you get the share allocation in your demat account and the stock is listed at a significant premium price. It is possible only when you are lucky to get the allotment of shares and that should be listed at a very higher price on the date of listing in the stock exchanges.
And that's not happening with every IPO launched in the market. Most of the time you will not get the allotment and luckily if you get the allocation, then there is a chance it is listed at a discounted rate or below the IPO issue price. Similarly, there are various risks involved in investing in an IPO, and you should know all these factors before investing there.
Risk of Investing in IPO
Is IPO risky? I think answering this question is not possible unless we get to know all the risk factors that are involved while applying for the IPO. Investing in the stock market is already a risky game, there are similar chances of increasing or decreasing your investment, especially in the short term. An IPO is the primary market where such risks are involved.
Sometimes traders or investors apply for the IPO, borrowed money from the banks or open the market at higher interest rates. And when they didn't get the allotment, they have to pay interest, and if they get the shares but are listed at much-discounted rates, then also their borrowed money will not become a profitable business instead called a risky bet.
Why is IPO Considered High Risk?
Certain things are making the IPO investment risky or you can say useless, especially if you do not get the allotment of shares. And another risk is at the time of listing, suppose stock is listed at much-discounted rates, you can lose some of your money. To know what the risk factors let's discuss in detail that are discussed below.
Disadvantages of IPO for Investors
Before we know about the disadvantages of IPO for investors let me tell you one thing before, that investing in IPOs is different from buying and selling stocks from the secondary market. Some traders invest in the IPO with the speculation to make money in the short term when stock will be listed at a premium price in the stock market.
Top 5 Disadvantages of Investing in IPO:
- No Assurance of Share Allotment
The first and far most important risk, while applying in the IPO, is no guarantee that you will get an allotment of shares into your account. Applying in the IPO, there is a limit for each category including retail investors. In India, from one demat account, you cannot bid at cutoff price more than Rs 2 lakh into IPO with the lot size defined in the IPO.
And when an IPO is fully subscribed or oversubscribed there is very less chance of getting the allotment. If the stock launched in IPO is worth investing Instead of applying in the IPO, you can buy shares from the secondary market after the listings.
- Money Locked for Many Days
When you apply for the IPO, you have to pay the application money as per your lot size and price of the each share you bid in the IPO. During the IPO launch, there are different stages till the listing of the shares, till then your money is blocked.
From the launch date to, the IPO closed date, share allotment and finally listing day, it takes 7 to 10 days in India. If you do not get the allotment, it will be known only after the closing of the IPO. This money not in use for that period, can be invested somewhere else.
- Risk of Shares List at Discounted Price
This is one of the highest risks applied in the IPO. Yes, if you have applied for shares in IPO and on the listing day if the stock is opened at a very low price, there could be a huge loss for you. However, either you can wait till your investment becomes profitable or breakeven, or you have to incur a loss selling the shares at the discounted rates in the market.
To know whether the IPO will perform well on the listing day or can give good returns in a few days after listing keep tracking the grey market premium (GMP) price that is disclosed after the IPO open date and before the listing of the shares in the market. If GMP is at a high premium you can invest in IPO which can give you good returns on the listing day.
- High Volatility in the Market
Just like the secondary market, there is high volatility in the primary market too. When an IPO is launched, as per the demand and supply of the shares in the IPO, the GMP is fluctuating, making the IPO price highly volatile. And the volatility is not only limited to the primary market, even after the listing of the share it is not stable due to demand and supply there too.
Such high volatility of GMP and share price in the secondary market makes the IPO investment very risky. You should avoid buying such stocks from the IPO, you should wait till the shares price stabilizes after listing in and then decide whether to invest or not.
- Unavailability of Information of Unlisted Companies
This is one of the very important and crucial factors while investing in the stock market. The unlisted companies are not legally bound to disclose their financial details and corporate actions. When you invest in an IPO, you will not get enough information about such companies. And investing in such less transparent companies would be a risky bet.
Though, before launching the IPO companies file a Draft Red Herring Prospectus (DRHP) with SEBI, in which all the details are disclosed. The company release all their financial details, management and board of directors, and it’s operations or corporate actions the company is going to take shortly and what and how it will use the fund generated through IPO.
Apart from all the above-said risks of investing in an IPO, various other factors discourage investing in an IPO. If the stock price is overvalued, you will not get a profit instead might incur a loss on the date of listing. Hence, investing in an IPO, you need to be very careful and keep in mind the risk, returns and feasibility to get maximum outputs.
Investing in the IPO is worth only when you get the allotment of shares and the stock gives you a significant profit on the day of listing or later. If the stock price is listed at a heavy discount and your money is stuck, it would be the riskiest investment.
In such situations, you need help of the experts, who can analyze the IPO shares and find out whether it is undervalued or overvalued. If the stock price is undervalued and there is a chance of getting the shares in the allotment, then you can apply otherwise ignore it.
Also Read: How to Increase the Chances of IPO Allotment
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