What drives SME IPO mania? 6 key points retail investors should know before applying for an issue

by Admin

SME

India’s capital markets have been buzzing with activity, with a remarkable surge in Initial Public Offerings (IPOs) this year. While over 55 mainboard IPOs have already hit the market, the real excitement is seen in the Small and Medium-sized Enterprises (SME) segment. With more than 150 SME IPOs launched in 2024 alone, this surge reflects the growing confidence and optimism within India’s financial markets. However, this trend also raises critical questions about the sustainability of such growth, particularly regarding the quality and fundamentals of the companies going public.

The Positive Side: Economic Growth and Market Sentiment

The influx of IPOs, especially from SMEs, is generally a positive sign. It reflects an upbeat market sentiment, indicating that investors are confident in the market’s future prospects. More importantly, the increased participation of SMEs in the capital market is a strong signal of economic growth. SMEs are the backbone of India’s economy, contributing significantly to GDP and employment generation. Their access to public funding through IPOs can be a game-changer, helping these companies scale up operations, invest in innovation, and create more jobs.

The Dark Side: Retail Investors’ Obsession with SME IPOs

While the surge in SME IPOs is a positive development, there is a growing concern about the intense obsession of retail investors with these offerings. Many of these investors are flocking to IPOs of companies that lack strong financials or a proven track record, driven by the allure of quick listing gains rather than sound investment principles. This trend is alarming because it can lead to speculative excesses, which have historically resulted in significant financial losses for retail investors.

Perplexing Oversubscription: What’s Driving the Mania?

Several SME IPOs have seen extraordinary oversubscription, leaving market experts puzzled. Retail investors, in particular, seem to be chasing these IPOs with little regard for the underlying business fundamentals. This mania is driven by several factors:

  1. Pursuit of Listing Gains: Retail investors are often drawn to IPOs by the prospect of quick gains on listing day. The idea of making a substantial profit in a short period is highly appealing, especially in a market where liquidity is abundant.

  2. Fear of Missing Out (FOMO): The fear of missing out on potential profits is another significant driver. With so many success stories of investors making hefty returns from IPOs, there is a growing tendency to jump on the bandwagon without fully understanding the risks involved.

  3. Abundant Liquidity: High liquidity in the market has also played a role in fueling the SME IPO frenzy. When money is readily available, investors are more likely to take risks, often disregarding the fundamentals of the companies they are investing in.

  4. Desire for Quick Wealth: The aspiration to get rich quickly has led many retail investors to take on risky bets in the SME segment. However, this desire often blinds them to the potential pitfalls of investing in companies with weak financials.

The Risks of Chasing SME IPOs

While the excitement around SME IPOs is understandable, it comes with significant risks. Unlike mainboard IPOs, SME IPOs often lack the same level of scrutiny and regulatory oversight. Many SMEs going public do not have strong business models or sound financials, yet they attract retail investors who are more interested in short-term gains than long-term stability. This can lead to severe consequences, especially for those who borrow money to invest in these IPOs.

The Dangers of Borrowing to Invest

One of the most concerning trends is that some retail investors are borrowing funds from banks or other sources to invest in SME IPOs. This strategy can be disastrous, particularly when the stock does not perform as expected on listing day. A flat or negative listing can lead to significant financial losses, leaving investors not only with a depreciated investment but also with the burden of repaying the borrowed funds with interest.

The Blind Bet: Lack of Due Diligence

Ideally, before investing in an IPO, investors should thoroughly research the company’s business model, financial health, growth prospects, and market position. This due diligence is crucial to making informed investment decisions. However, experts point out that many retail investors are making blind bets, relying on superficial indicators like subscription numbers, Grey Market Premiums (GMP), and the reputation of the merchant banker behind the issue.

The Mathematics Behind the Frenzy

There is a simple arithmetic that explains the frenzy of retail investors for SME IPOs. On the mainboard, the average lot size for a retail application is ₹15,000. In the SME segment, the lot size varies between ₹1,10,000 and ₹1,30,000, making it significantly larger. The potential returns are also magnified—while a 30-40% gain on a mainboard IPO might yield ₹6,000, an 80% return on an SME IPO could result in a profit of around ₹96,000. This difference in potential returns is a major factor driving retail investors toward SME IPOs, despite the higher risks involved.

Key Considerations for Retail Investors

Given the risks associated with SME IPOs, retail investors must adopt a more cautious and informed approach. Here are some key points to consider before applying for any IPO:

  1. Understand the Business: Investors should have a clear understanding of what the company does, its business model, and how it plans to use the IPO proceeds.

  2. Financial Health: Examine the company’s financial statements to assess its profitability, growth potential, and debt management. A strong financial foundation is crucial for the company’s long-term success.

  3. Market Trends and Industry Context: Consider the industry in which the company operates and the current market trends. Companies in growing industries with favorable market conditions are likely to offer better investment prospects.

  4. Competition: Analyze the company’s competitive position within its industry. A strong competitive edge can indicate a more stable and profitable future.

  5. Valuation: Compare the IPO price with those of similar companies in the market. An overpriced IPO may not deliver the expected returns.

  6. Red Flags: Be cautious of companies with inconsistent financial projections, rapid growth that seems too good to be true, or a lack of operational history. These could be signs of underlying issues.

  7. Lock-up Periods: Understand whether there is a lock-up period that prevents insiders from selling their shares immediately after the IPO. This can impact the stock’s supply and demand dynamics.

Regulatory Reforms: A Call for Action

While it is not advisable to dismiss SME IPOs outright, there is a pressing need for greater transparency and regulatory oversight in this segment. Experts believe that market regulators like SEBI should step in to ensure that the SME IPO process is more transparent and less prone to speculative excesses. For instance, the involvement of Qualified Institutional Buyers (QIBs) and anchor investors in SME IPOs has raised concerns about potential exploitation of loopholes in the allotment process. Reforms in this area could help protect retail investors and maintain the integrity of the market.

Conclusion: Balancing Opportunity with Caution

The surge in SME IPOs presents both opportunities and challenges for retail investors. While the potential for high returns is attractive, it is crucial to balance this with a thorough understanding of the risks involved. Retail investors should avoid the temptation of blind betting and instead focus on conducting comprehensive research before making any investment decisions. With greater caution and regulatory oversight, the SME IPO segment can continue to contribute positively to India’s economic growth, while minimizing the risk of speculative excesses

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