Investing in Initial Public Offerings (IPOs) – Good or Bad?

Investing in IPOs launched by companies can help you generate a substantial amount of wealth based on whether your thesis about the company’s future stands true or not. As a form of stock market investments, IPOs have huge risks involved and investments in them can result in massive gains or losses. 

So, if you are debating whether or not to invest in IPOs, give this blog a read. Here you will get  clear insights into the pros and cons of IPO investment. 

What are the pros of investing in IPOs?

• High liquidity

After buying shares in an IPO, you can sell them off in the secondary market once the company is listed on the exchange. These shares will become part of the secondary market, where they will be traded as per supply and demand. This feature ensures the liquidity of the stock.  

• Chances of listing gains

Investing in IPOs also gives you the chance to profit from listing gains. If the company’s stocks trade at a higher price on the listing day than your buying price (allotment price), you can profit from the listing gains. 

• Wealth generation

Purchasing shares of promising businesses during their IPO launches is an excellent way to generate wealth. This is because, if the company has substantial growth in the long term, the stock price will appreciate in value allowing you to gain massive profits.   

• Increases diversity of your portfolio companies

When you buy shares in IPOs, stocks of new companies get added to your portfolio. This increases the diversity in your portfolio and reduces the overall risk of your holdings. 

• Economical

IPOs are supported via the ASBA feature, wherein the amount is debited from the account only if shares are allotted, and until then the amount is blocked by the bank, but it still continues to earn interest.

What are the cons of investing in IPOs?

• No guarantee of share allotment

Applying for shares in an IPO does not guarantee that you will be allotted shares. More often than not, the demand for a company’s shares among investors during an IPO exceeds its supply. Thus, the organisation is unable to allot its shares to every investor. 

Under such circumstances, it conducts a computerised lottery to choose individuals who get to be shareholders of the company. Hence, the probability of getting allotted becomes a matter of luck. 

• High price fluctuations

During the early stages post IPO, there is high volatility in its share prices. This is because the organisation is still newly listed and thus there is a fluctuation in investor sentiment. In such cases, there can be a significant fall in share prices and you may incur listing losses.

Moreover, if there is high volatility, regulators may freeze or restrict trading activities. This can have a negative effect on liquidity. 

• Inadequate historical data

For newly listed companies, you may not find enough historical data to assess their past performance, especially for companies which have started operations in the last few years . Under such circumstances, it may become difficult for you to choose whether to invest in them during the IPO round. 

• Overvaluation

A company’s share price during an IPO depends on various factors like industry trends, demand, future growth prospects, and more. However, due to the recent increase in the popularity of IPOs, there is a high chance of stocks being overvalued during an IPO launch. 

This will result in investors losing money when the market corrects itself and the share price falls drastically.     

Is IPO investment a wise decision? 

Despite all the pros and cons, investing in IPOs can be an excellent way to add high-quality stocks to your portfolio. They may suffer from volatility in the short term; however, if your investment horizon is long enough, there is a high chance of getting lucrative returns. 

Moreover, if factors like the business model, financial management, industry trends, and past performance are robust, it increases the chances of wealth generation in the long run.  

Final Words

Every form of investment in the stock market comes with its own set of risks. An IPO investment can be risky, as the stock can get volatile immediately after getting listed on the stock exchanges. So, make sure to conduct a thorough market analysis and assess the current industry trends before going ahead with any investment decision. 

Frequently Asked Questions