Is trading IPOs a feasible investment strategy?

Over the past few weeks there has been a rush for liquidity in the market as investors experienced a frenzy of back-to-back initial public offerings (IPOs). There were four in total with two upcoming listings on the Jamaica Stock Exchange (JSE) main market – Wisynco Group Limited and Victoria Mutual Investment Limited and two on the junior market – FosRich Company Limited and GWEST Corporation Limited all of which were significantly oversubscribed.

This has drawn increased attention to the market as individuals are becoming more familiar with the stock market but have expressed special interest in these public offerings. The sudden rush of investors scrambling to deliver applications in an effort to acquire a piece of the action seems to be the new norm. The overall track records have proven that new market listings have the potential to deliver favourable returns within a short period of time however; they can also pose serious risks for investors if proper due diligence is not executed. Often time decisions are made before there is any real assessment of the company’s fundamentals along with the level risk associated. Recent dialogues have led me to believe that investors seemed to have taken on the strategy of investing in IPOs with the hopes of being able to quickly turnover of profits even if the stock valuation is expensive relative to that of the market. It is obvious that investors’ decisions are not dependent mainly on fundamental analysis but more open to take risk based on speculative reasoning and market demand.

The question frequently asked is if trading IPOs are feasible investment strategies/approaches? The answer to this is neutral as this approach does have its advantages and disadvantages. For investors with the intention of doing this only for a short term- it is important to note that IPOs tend to be extremely volatile at the initial stages; there also exist a mismatch between buyers and sellers in the market which can result in the overpaying or under selling of a stock. The success of realizing capital gains will be determined by one’s ability to time the market in order to identify when the best time to sell. This process can be time consuming and very difficult for one to assess. Investors will also need to factor in the levels of liquidity associated with the stock which makes it easier for trading. In most cases, if the level of demand outweighs supply there will be an increase in the stock price which is the case with most stocks. One will start to realize a trend of increase selling which cause a shift in the overall demand and supply that eventually results in a market correction and the company’s shares may fall to reflect its actual valuation.

Investing in IPOs is like investing in any stock that is already listed on the market – there are no guarantees that they will perform to fulfill or exceed investors’ expectations. Timing is also an important factor when an individual investment goals and objectives are taken into account. Too often investors are left holding shares that is trade below the initial price offered or wanting to offload and not being able to because of the lack of liquidity.

On the safer side, a medium to long term investment strategy is far more prudent and tend to yield far greater returns overtime. With this approach investors want to have more knowledge of how well this investment mirrors their investment risk profile to fit into their overall strategy or objectives. Assessing the potential risk and rewards of investing in the company is also very important step to consider. Investors should be able to grasp the general concept about the company that they are planning to invest in, by trying to understand the company’s business model along with their fundamentals. Look carefully on how the company has been generating earnings as well as the projected growth trajectory and earning potential of the company.

The number of IPOs has been increasing since 2014 at a very high success rate. Most companies that went to the market have successfully raised capital and their stock prices have performed very well even with proposed high valuations. Buying into a newly public company for sure is an opportunity to get in on the ground as it may be cheaper to buy shares at IPO price, especially if the company is believed to have strong growth potential. Many companies especially on the JSE junior market today have seen their stock value increased way above the price since going public. For example Blue Power Group Limited (JSE: BPOW), Knutsford Express Limited (JSE: KEX), Cargo Handlers Limited (JSE: CHL) just to name a few.

Ultimately, it is indeed an opportunity to take advantage of upcoming IPOs and the potentially lucrative returns they may offer. However, it is always prudent to ensure that you critically review all of the pros, cons, and seek expert opinions before making a decision.