From Nykaa's soaring IPO to Paytm's plunge: Understanding the risks beyond the hype

The success story of Nykaa doesn't necessarily repeat itself in every Initial Public Offering (IPO). 

Falguni Nayar, an IIM Ahmedabad alumna, carved out a rare success in the market. After stepping down as the managing director of Kotak Mahindra Capital, she founded Nykaa at the age of 50. Nine years later, Nykaa, focused on beauty products, went public with a highly successful IPO. The stock surged by 89% on its listing day, catapulting Nayar's personal wealth to Rs 48,750 crore ($650 million). Investors also reaped significant gains.

However, the story of Paytm tells a different tale. 

Launched in 2000 under Vijay Shekhar Sharma, Paytm (One97 Communications Limited) initially focused on mobile recharges and related services. 

Despite never turning a profit, Paytm's IPO was priced at Rs 2,150 per share. On the day of listing, its price plunged to Rs 1,564 -- one of the steepest intra-day declines for a stock in the past decade.

The stock market can sometimes appear as a stage where companies, particularly startups, attract foreign investors, raise vast sums of money, and launch IPOs. 

Through an "offer for sale", founders and early investors cash out, securing their positions. This is the reality of the stock market -- a dynamic environment where companies queue up for IPOs, especially when indices are hitting new highs.

Many retail investors, eager to make quick money, ignore the intrinsic value of these companies. Their sole aim is to sell on the listing day for an instant profit, often based on grey market premiums. 

Companies, too, focus on attracting multiple times the applications for their IPOs, aiming for a stellar debut. But after the initial excitement fades, some of these companies may flounder like a kite in the wind. 

It is crucial for investors to focus on long-term returns rather than chasing listing-day gains. The goal should be to build a solid stock portfolio. Investors who overlook this may risk losing their hard-earned money.

IPO Frenzy

After a lull, the IPO market picked up again in 2021. Rs 63,985 crore was raised through IPOs by 60 companies till August in calendar year 2024. In comparison, 57 companies raised Rs 49,436 crore in 2023, marking a 29% jump.

In a bullish market, the desire for quick profits pushes companies to take advantage of investor sentiment. However, IPOs are not necessarily golden opportunities for retail investors. 

When pricing their shares, companies often focus on how much capital they can raise rather than the true valuation of the business.

Retail investors tend to overlook the valuation of IPO-bound companies, focusing instead on listing-day profits. It is important to remember that not all IPOs are success stories. Some companies have faced significant losses. 

Take Paytm, for instance. Out of its Rs 18,300 crore IPO, only Rs 8,300 crore represented newly-issued shares. Promoters and private equity investors sold Rs 10,000 crore worth of shares through the offer for sale. They exited at the best price per share, with Paytm's MD and CEO Vijay Shekhar Sharma cashing out Rs 402.7 crore by selling 18.73 lakh shares. 

Promoters, private equity investors, and large investment banks are strategic when they list a company.

Policy Bazaar also faced a similar decline as Paytm. Within two days of listing, Paytm's share price fell by 40 per cent, while Policy Bazaar lost 18 per cent. In case of Zomato (in four trading days) 16 percent. 

Why this similarity? A little thought will give you an easy answer. The fact is that even though these companies have become the centre of attention in the country as start-ups, they have not yet been able to cry from their losses. These startups came into the market by declaring themselves as the businesses of the future.

Is an IPO the best opportunity?

Not always. Even companies with strong operating histories and solid financial foundations can see their valuations inflated by promoters and early investors during an IPO. 

Investment bankers and institutional investors contribute to this by pushing IPO subscriptions up to 5-10 times. The reality is that after the initial excitement fades, stocks can often be acquired at more reasonable prices post-listing. In some cases, you could buy shares at a 50% discount within a year.

If you miss out on an IPO, don't feel bad. There are plenty of other ways to generate better long-term returns. Instead of chasing IPOs, consider waiting a year after a company lists to see how the stock settles. By then, the hype will have diminished, and you may be able to acquire shares at a more attractive price. 

Rather than fixating on IPOs, investors should focus on systematic investments.

Focus on SIPs: A More Reliable Approach

Avoid the temptation of quick profits and adopt a systematic investment approach. Invest regularly in stocks or mutual funds through a Systematic Investment Plan (SIP). 

Over time, SIPs tend to deliver better returns compared to the temporary highs—and potential losses—of IPO investments.

Caution and Strategy

While stories of IPO windfalls may circulate among friends or relatives, it’s important to recognize that these successes are exceptions, not the rule. 

Making money from IPOs is far from easy, and there's a very real risk of losing your hard-earned capital. The market has seen both spectacular IPO successes like Nykaa, and devastating failures like Paytm. This is the nature of the stock market, particularly in bullish cycles. Investors must approach IPOs with caution, keeping their long-term financial goals in mind, and focusing on building a diversified and balanced portfolio over time.