In recent years, the financial markets have witnessed a surge in Small and Medium Enterprises SME IPOs, while some of these SME IPOs present unique opportunities, they also carry significant risks that investors specially ‘retail’ should be keenly aware of. As the frenzy around SME IPOs continues to grow and reaching a dangerous levels, it’s essential to understand the nuances and potential pitfalls associated with investing in these relatively smaller and less established companies.
Understanding SME IPOs: An Overview
Small and Medium Enterprises (SMEs) are businesses whose personnel numbers fall below certain limits (Investment in Plant and Machinery, from 1cr up to 10cr and turnover from business up to 25cr). In most cases, these enterprises are privately held, with their shares not available to the general public until they decide to list on a stock exchange.
An Initial Public Offering (IPO) is the process through which a private company offers its shares to the public for the first time. An SME IPO, therefore, is when a small or medium-sized business decides to go public to raise capital for expansion, debt repayment, or other business needs.
The Growing frenzy of SME IPOs
The allure of investing in SME IPOs is primarily driven by the potential for high returns. Given that these companies are in their growth phase, they can offer substantial returns if they succeed. The lower valuation at which these companies often go public makes them appealing to retail investors looking for high-growth opportunities at a relatively low entry cost.
Moreover, regulatory changes and supportive measures from governments and financial bodies have made it easier for SMEs to access capital markets. Stock exchanges have also established dedicated platforms for SMEs, providing them with a more accessible route to public listing. Regulatory exemptions like-
Reduced disclosure requirements: SME issuers are required to provide less detailed information in their prospectus compared to mainboard IPOs.
Lower listing fees: SME IPOs generally have lower listing fees charged by stock exchange.
Simplified listing process: The process for listing an SME IPO on a stock exchange is less complex compared to mainboard IPOs.
Why Retail Investors Should Approach SME IPOs with Caution
While the potential for profit in SME IPOs is enticing, retail investors should exercise caution due to several inherent risks associated with these investments.
1. Lack of Historical Performance Data
Unlike larger, well-established companies, SMEs often have a limited track record, making it challenging for investors to assess their long-term financial health. The lack of historical performance data means that retail investors often have to rely on the company’s prospectus and management’s forward-looking statements, which can sometimes be overly optimistic or fail to provide a complete picture of the company’s actual risk profile.
2. Higher Volatility and Market Risk
SME stocks are typically more volatile than their larger counterparts. The smaller market capitalization means that these stocks can experience significant price swings due to lower trading volumes and reduced liquidity. This volatility can lead to substantial losses, especially if market sentiment turns negative or if the company fails to meet its growth projections. Retail investors who are not prepared for such volatility might find themselves making impulsive decisions that lead to financial losses.
3. Information Asymmetry
There is often a significant information gap between what insiders (such as the company’s management and early investors) know about the company and what is disclosed to the public. SMEs may not have the same level of regulatory scrutiny or transparency as larger firms, which can result in information asymmetry. Retail investors, with limited access to inside information, may not fully understand the risks involved or the company’s actual business prospects.
4. Potential for Overvaluation
The frenzy around SME IPOs can sometimes lead to overvaluation. High demand for these shares, driven by speculative buying and media hype, can inflate stock prices beyond their intrinsic value. Retail investors entering the market at these inflated prices risk significant losses if the company’s performance does not justify the high valuation, or if market conditions change unfavorably.
5. Liquidity Constraints
Unlike larger companies listed on major exchanges, SMEs may not have a wide investor base, which can lead to liquidity constraints. This means that it could be difficult to sell shares quickly without affecting the stock price, especially during times of market stress. Retail investors might find themselves stuck with shares they are unable to sell at a reasonable price, leading to potential financial strain.
Recent SME IPO performances
In 2024, more than 160 SME companies have launched IPOs and all of them have received bumper response from d-street investors. The frenzy for these small IPOs can be guessed by looking at subscription figures of these companies, many among them received subscriptions up to 400-500x against offer made. Among these only handful of are trading below their issue price and many have gone up up to 15-16x against their issue price within just few months, so hope of quick gain is driving investors crazy.
Biggest winners from SME IPO pack are-
- Owais Metal and Mineral Processing Limited: up more than 15x from issue price within 6 month of listing. the 42cr ipo was a book built issue launched in march 2024 had received 221x subscription. With revenue of 80cr and profit of 15cr, company’s mcap now stands at outrageous 2,553cr. The co is engaged in the production and processing of metals and minerals.
- Australian Premium Solar (India) Limited: Up more than 8x from issue price, the 28cr issue was launched in Jan 2024 and received 535x subscription. With sales of 150cr and PAT of 6cr in FY2024, company’s mcap now stands at 969cr. It manufactures monocrystalline and polycrystalline solar modules and provides engineering, procurement, and construction (EPC) services for residential, agricultural, and commercial applications.
- TAC Infosec Limited: Up more than 6x from issue price, the 30cr issue was launched in April 2024. It received 433x bids against offered shares. With revenue of 11cr and PAT of 6cr, company’s mcap now stands at 894cr. It offers risk-based solutions for vulnerability management and assessment, cyber security quantification, and penetration testing in a SaaS model.
- Alpex Solar Limited: Up more than 5x from issue price, the 74cr issue was launched in Feb 2024, it received 352x bids against offered shares. With sales of 413cr and PAT of 27cr, co’s mcap now crossed 2,000cr. Alpex Solar Limited is a manufacturer of Solar panels using monocrystalline and polycrystalline cell technologies.
- Refractory Shapes Limited: Up more than 5x from issue price, the 18.6cr IPO was launched in May 2024. The issue received 259x subscription against offer. With sales of 40cr and PAT of 4cr company’s mcap is now over 400cr. Refractory Shapes Limited manufactures various types of Bricks, Castables, high alumina catalysts, and Ceramic Balls.
The recent case of Resourceful Automobile
With just 2 Yamaha dealerships, 8 employees and 18cr of sales, 42 lacs of PAT Resourceful Automobile launched its 12cr SME issue on August 22. Against its 12cr ask company received bids worth more than 2800cr summing up the SME ipo frenzy. The retail investor segment alone saw a 496x subscription, against overall subscription of 400x. It shows the dangerous level of enthusiasm of SME IPOs among investors.
Strategies for Retail Investors to Mitigate Risks
To navigate the complexities of SME IPOs, retail investors should adopt a cautious and well-researched approach. Here are some strategies to consider:
1. Conduct Thorough Due Diligence
Before investing in any SME IPO, it is crucial to conduct thorough due diligence. This involves reading the company’s prospectus in detail, understanding its business model, assessing its competitive advantages, and evaluating its management team’s experience and track record. Investors should also consider the sector in which the SME operates and the broader market trends affecting that sector.
2. Diversify Your Portfolio
Investing in SME IPOs should be part of a diversified portfolio strategy. By spreading investments across different asset classes and sectors, retail investors can mitigate the risk associated with any single investment. Diversification helps reduce the impact of poor performance from one stock and can provide a more balanced approach to risk management.
3. Be Prepared for High Volatility
Retail investors need to be prepared for high volatility when investing in SME IPOs. This means having a long-term investment horizon and not being swayed by short-term market movements. It is also advisable to set stop-loss orders to protect against significant downside risk and to avoid making impulsive decisions based on market fluctuations.
4. Stay Informed and Updated
The landscape of SME IPOs can change rapidly. Retail investors should stay informed about any regulatory changes, market conditions, and company-specific news that could impact their investments. Subscribing to financial news services, attending webinars, and participating in investor calls can provide valuable insights and help investors make more informed decisions.
5. Consider Professional Advice
Given the complexities involved in SME IPOs, seeking professional financial advice can be beneficial. Financial advisors can provide personalized guidance based on an individual’s risk tolerance, financial goals, and investment horizon. They can also offer insights into the broader market environment and help investors make more strategic decisions.
Conclusion: Proceed with Caution
While SME IPOs offer exciting opportunities for growth and profit, they come with significant risks that retail investors should not overlook. By understanding these risks and adopting a careful, research-based approach, investors can navigate the SME IPO market more effectively. Remember, investing in SMEs requires not just capital but also patience, diligence, and a willingness to embrace a higher level of risk.
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