When people invest in IPO, they can buy shares when a company is listed on the stock market for the first time. An IPO can grab attention because it offers investors a chance to buy shares in a new public company.
But every IPO is a gamble. Share prices may change after listing Business conditions may change, as well. Investors should consider these risks before applying.
Important risks of Investing in IPO
1. Listing Price Risk
The issue price of the IPO is not the listing price.
A share can be quoted above or below its issue price. The price is set by market demand, investor interest, sector trends and general market conditions.
That means investors could lose money immediately after the listing if the share opens below the issue price.
SEBI has also mentioned that the issue price is not indicative of the price at which shares will trade after listing.
2. Lack of Trading History
A new listing company is a company that has no long stock market history.
Investors can look at its historical financial results. But they cannot study years of share price movements.
This can make it hard to understand how the stock might react in different market conditions.
3. Commercial Risk
Every company faces business risk.
This may be due to declining sales, increasing costs, high debt, stiff competition, legal cases or change in government rules.
RHP or Red Herring Prospectus covers the key risks associated with the company.
Investors should read carefully the Risk Factors section before investing in IPO.
4. Valuation Risk
The IPO price may not always reflect the financial position of the company.
A company may come to market at one valuation and that valuation may shift based on investor demand or company performance.
A high subscription of IPOs does not necessarily mean that the share price will stay up above issue price.
Before you apply, investors should look at revenue, profit, debt, cash flow and valuation.
5. Market Risks
IPO shares are also influenced by the general market conditions.
Interest rates, inflation, economic news, global markets and sector trends can affect share prices.
For example, a stock might drop because the whole market or sector is under pressure. It can happen even if there is no change in the company’s business in substance.
6. Risk of Liquidity
Liquidity is how easy it is to buy or sell shares.
There may be limited trading in some newly listed shares. In such cases, the investors may find it difficult to sell shares at the expected price.
SEBI has said there is no guarantee that an active trading market would develop after an IPO.
7. Risk of Allotment
IPO applications are not guaranteed to be allotted.
In the event of high demand, the number of applications may exceed the number of shares available
In these cases, the investor may get fewer shares or none at all.
In ASBA process, the application amount gets blocked in the bank account. Amount will be debited after allotment only.
8. Risk of Use of Funds
Investors should also find out the reason for the company raising money.
An IPO can be a fresh issue, an offer for sale or a combination of the two.
The company receives fresh issue money. They can be used for expansion, to pay down debt or for other purposes.
In a sale offering, the money goes to the current shareholders who are selling their stock.
The RHP describes the intended use of the IPO proceeds.
How to evaluate the risks of an IPO before investing
There is a simple process investors can follow before applying.
Read the RHP first, and then review the section on Risk Factors.
Then, consider the company’s revenue, profit, debt, and cash flow.
New investors should understand the basics before making investment decisions.
Look at the promoters and their business experience.
Compare the valuation with the listed companies in the same sector and review the price band where applicable.
Also see the use of the IPO proceeds.
An IPO being highly sought or in the eye of the market should not be a deciding factor for investors.
Bajaj Broking: Where It Belongs
Bajaj Broking provides information on IPOs that are open and upcoming. Investors can find details like price band, lot size, issue dates and other IPO details.
The platform also has online IPO application process.
These features can help investors get IPO information and complete the application process. Investors should still read the RHP and financial details before taking a call.
Conclusion
There are several risks in investing in an IPO. These include risk on listing price, business risk, valuation risk, market risk, liquidity risk and allotment risk.
Investors should study the company, read the RHP, check financial data and understand usage of IPO funds.
Investors can understand the risks before they submit an IPO application by conducting a comprehensive review of the Initial Public Offering Meaning and its associated risks.
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