Can retail investors subscribe to IPO

May 22, 2017

In the recent times, there are lots of companies announcing Initial Public Offers (IPOs). Certain IPOs have sky rocketed on opening day and have given huge returns for the investors. On the other hand, certain popular companies are now trading at discounted price. Due to this, retail investors are doubtful about investing in IPOs.

Why IPO is necessary?

For economic growth of a country, good IPO market is inevitable. Capital mobilization (Collecting of funds) happens through IPO. When capital market operates well, investments will be utilized properly. When a company issues IPO,the market reacts positively to it if the company has performed well in the past.

Capital mobilization happens easily for the company and the IPO will be a huge success. But those companies that have moderate performance and those that are not much popular generally face a failure when they get listed in the stock exchange.

So it is evident that the companies that perform better can raise a decent capital. Considering the economic growth and production, above mentioned point is logical and appropriate. But practically, it is not exactly true.

Because, it is not so easy to predict if the new entrepreneurs can take their business in a successful path. In 1994, when Infosys issued IPO, it gave unimaginable returns to its investors. But it had very less subscription rate. At the same time, though front line companies seek funding for its new ventures, it could be a failure business in future. These contradictions are making IPO investments a huge challenge.

But with proper planning, retail investors can successfully invest and get good returns from IPO.

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IPOs in the past:

Indian markets began its growth phase only after foreign exchange regulation reforms in 1970s. With this regulation, the multinational companies were insisted to get listed in the Indian stock exchange so as the regulations to get lifted. Colgate and HUL are examples of such companies.

Since the IPO price of such companies were determined by Controller of Capital Issues, it is reduced deliberately. Investors who bought these company shares enjoyed good returns later.

In 1980s, IPO markets improved further and remained profitable. But thereafter, many problems started to arise. Several new companies issued IPO and accumulated huge funds from retail investors. But the investors ultimately faced losses. As there were no regulations at that point of time, shareholders of newly listed companies were often disappointed.

Even today, retail investors are getting cheated by certain promoters. Let’s see how retail investors can safeguard themselves from such happenings.

SEBI’s regulation

Based on experiences from the fraudulent activities so far, Securities and Exchange Board of India (SEBI) has taken following actions to prevent the retail investors from falling prey.

  • Maximum price for IPO is based on number of shares being issued. When subscription rate is more than the number of allocated shares to be issued, many retail investors will not be able to get allotment of the stock.
  • Minimum investment amount has been increased from Rs.5000 to Rs.7000 range to Rs.10000 to Rs.15000 range.
  • Opening of demat account in a very low cost and zero yearly maintenance charge (in case of investments not exceeding Rs.50000).
  • Easy application procedure and online application through stock brokers.
  • Non retail investors cannot sell their shares when the listed stock faces correction.

Differentiating good IPO from the ones to be avoided

While such regulations are praiseworthy, only these steps will not safeguard the retail investors. Big threat for retail investors are the greedy promoters seeking huge profits who manipulates IPO praises and not caring about the high fees mandated by investment bankers. In the past years, many companies have manipulated the IPO praise and looted money from the investors.

In the year 2015, out of 55 companies that got listed, 39 traded at premium price while 16 were on discounted price. From these, it is clear that investors can participate in IPOs but they should be aware of selecting quality companies. Choosing superior companies at right prices and discarding companies that issue IPOs at high prices just to prove its operating capacity are the skills each investor should get trained on.

Determining the right price

It is always a challenging task to find out the right price for the IPO. It is not wise to judge solely based on the financial parameters of the company. Market sentiments and expectations have played a major role all the time. Past and present situations alone are not taken into account by the markets. At this point, there is no proper expert guidance for the retail investors who can thoroughly research and share information about the IPO. Hence, the investors are able to weigh only certain indirect parameters.

For example, the dependencies and requirements of a company is a major parameter for judging the quality of the IPO issue. This may not be applicable in certain cases. When large number of investors subscribe for numerous shares, the expectation of the stock shoots up and retail investors are often enticed by this.

Currently, as per SEBI’s norms, those other than retail investors can neither reduce their subscription rate for the IPO nor take out their investment after listing. Also, it has been mandated that the promoters have to share their past records and other sector related information. Due to these, the problems of retail investors have been offloaded to a certain extent.

Righteousness of promoters

Investors should avoid the risk of dealing with unknown promoters though they have been performing well. Also, it is better to avoid companies that operate on a low margin due to heavy competition. Above all, promoters should refrain from manipulating prices to attract investors. Investment bankers should not associate with the promoters to play on investors’ money and the bankers should strictly collect the maximum premium from the promoters.

Cheating investors and gaining profit can be advantageous for the companies but they should realize how it affects the stock market and the economy of the country. SEBI’s guidelines should be strictly followed by all class of people including Promoters, Investment Bankers, High Network Individuals and the Retail Investors. On following all these, each IPO investment will turn profitable for the investors and there is no doubt that our country’s economy will continue to flourish.

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