Understanding the Risks of Unlisted Stocks Amidst a Surge in IPOs
As the financial landscape buzzes with numerous Initial Public Offerings (IPOs) on the horizon, investors are increasingly drawn to unlisted stocks, often under the impression that these shares represent exceptional value. However, the recent pricing revelations surrounding HDB Financial Services serve as a stark reminder that not every unlisted stock is a golden opportunity.
The HDB Financial Services Case
HDB Financial Services recently announced an IPO price band of Rs 740, a staggering 40% drop from its unlisted market value of Rs 1,225. This decline has left earlier investors, who purchased shares at Rs 1,550 last year, facing a significant 52% devaluation before the stock even hits the market. Such volatility raises critical questions about the reliability of unlisted stocks as a safe investment.
The Illusion of Easy Gains
The allure of pre-IPO stocks often stems from the belief that they offer a shortcut to assured returns. However, this notion is increasingly being challenged. Anand K Rathi, Co-founder of MIRA Money, articulates a common sentiment among seasoned investors: “You can’t buy companies at any price just because they are getting listed.” He emphasizes that many informed investors are ready to unlock value by offloading shares before the IPO, leading to a potential liquidity trap for retail investors.
The Risks of Unlisted Shares
The unlisted stock market is fraught with risks, primarily due to its opaque pricing and liquidity issues. Rathi points out that the post-listing lock-in period of six months can be a significant hurdle for retail investors. Often, these investors rush in just before an IPO, driven by the illusion of easy listing gains, only to find themselves trapped in a volatile market.
Historically, HDB shares traded at around Rs 600 two years ago. The surge in unlisted prices was largely due to the freezing of employee holdings, which restricted supply. However, the announcement of the IPO price has since deflated these speculative valuations, leaving many investors in a precarious position.
The Appeal of Unlisted Stocks
Despite the risks, some investors have reaped rewards from unlisted stocks. Krishna Patwari, Founder & Managing Director of Wealth Wisdom India Pvt. Ltd., notes that several investors who entered HDB shares in the Rs 200–400 range five or six years ago are still enjoying healthy gains. This highlights that while unlisted stocks can be risky, they can also yield significant returns if approached strategically.
Retail investors often gravitate toward pre-IPO shares due to the low chances of receiving IPO allotments, which limits their exposure. Pre-IPO investments can provide quantity, but they come with inherent risks that must be carefully considered.
The Importance of Valuation
The crux of successful investing in unlisted stocks lies in understanding valuation. Patwari warns that while unlisted stocks can be a viable long-term investment, knowing what you’re paying for is crucial. The hype surrounding an IPO can easily blind investors to the underlying financial realities.
A strategic approach involves investing several years prior to an IPO, when companies typically signal their listing intentions through annual reports or staff communications. Once the IPO hype begins, the odds of making a sound investment can become a 50:50 game.
Positive Outcomes and Cautionary Tales
While there are success stories, such as Tata Technologies, BSE, ICICI Prudential, Nazara, and Barbeque Nation, where post-listing returns have been substantial, caution is warranted. Radhika Gupta, MD and CEO of Edelweiss Mutual Fund, expresses concern over the current enthusiasm for unlisted stocks, describing it as a misrepresentation of excitement. She emphasizes that this asset class, originally intended for high-risk early-stage investing, is now being marketed as a foolproof opportunity.
Conclusion
As the IPO landscape continues to evolve, it is essential for investors to approach unlisted stocks with a discerning eye. While there are opportunities for significant gains, the risks associated with valuation, liquidity, and market volatility cannot be overlooked. Understanding the nuances of this investment space is crucial for making informed decisions that align with long-term financial goals. In a world where the next big IPO can seem like a golden ticket, a grounded perspective on unlisted stocks is more important than ever.