Psychology of IPO investment

21 Sep 2020  Read 1621 Views

Do you like mysteries? Like reading mystery books or watching mystery movies? I think, as a kid, we all enjoyed reading mystery novels and watching a thrilling film. These days investors are enjoying these mysteries in the capital market. Yes, you guessed it right; I am talking about IPO investments.

Markets are going up, and investors have all the reasons to invest in the stock markets now. Nowadays, Initial Public Offer is getting very popular among investors, and most of the people who participate in the secondary market are through IPO. The most recent example which we all have witnessed is the Happiest Minds IPO, which was oversubscribed.

Why do companies come up with an IPO?

Before understanding the reason why people are herding behind IPOs, let’s first understand why companies come up with IPOs. 

  • A fundamental thing why IPO was discovered is to raise resources from the market. 

  • Secondly is because of the evil management of the cash boom. As we have discussed in our previous blogs of behavioral finance that investors are irrational. When they are just looking at a fast bug, the management tries to capitalise on that.

  • When investors are ready to pay a fancy price, if you will notice the current market, there are a lot of IPOs are launching now. And when markets were down a few months back hardly, any IPOs came. Do you know why? It’s only in bullish times when IPOs are launched in the market. This is because investors are ready to pay a very fancy price for any piece of paper that comes into the market.

Reasons why IPO Investments are a big hit 

IPO is always associated with profits. Several behavioral anomalies of investors and management are working towards this. So let’s understand this.

  • Investors always want something new, which is a novelty and discard the old. Typically all IPOs come up with something new, and people get excited by it.

  • Secondly, an IPO investment has no track record, and typically investors tend to believe in the value of mystery because they think there is something different that will be going to happen, maybe some sort of adventure. 

  • Mostly it’s about the new industry growth. For example, a pharma company plans to work on a new drug for any disease and may up for the IPO of the same. 

  • People start following a pied piper. Pied piper is when people start following a big brand or a prominent merchant banker is launching an IPO, and people tend to buy them. This an IPO psychology error, which we have discussed further in this blog.

Let’s understand this with an example of Reliance power when they came with an IPO. It was a new company that was formed by Mr. Anil Ambani, and power was a fancy that time in the market. In this company, 45% was taken by Mr. Anil Ambani and 45% by his existing company, Reliance Energy, and rest they went for public issue. So he came up with a share of rupees 10 with a premium of 430 to 450 rupees. This happened because they had a significant thing with them. The brand of “Reliance.” Afterward, it was the biggest laggard in the Indian market.

And so there can be so many reasons why investors are running for IPOs because the layer of the mystery is so much that investors are willing to pay much higher prices for something unknown rather than what’s known.

Psychological errors: What should be the Psychology of IPO investment?

  • Recency Bias is a bias in which recent information affects our decision making. Let’s take an example in a bullish market; investors think that markets are going up, and they will keep going up. So IPOs enter in this market, and investors with this bias usually tend to buy these IPOs because they think markets are going up, and they will book profits on the IPO, this may happen or may not occur.
  • Underpricing Heuristic - Whenever an IPO comes in, the market investors think that it is underpriced because the investment bankers, along with the company, would never show that their IPO is overpriced because then investors won’t buy it.

Conclusion

Investors who are buying IPOs are not buying a business, so if you are a long term investor, make sure that you are buying a profitable business and not just following the herd. IPOs are most of the times are issued at a premium and not at a discount. Recently there are so many IPO launches that are awaiting for investors, for example, CAMS IPO, Angle Broking IPO, Route mobile limited IPO, and so many, therefore Don’t let your biases overpower you, and before investing in an IPO, do check if any biases guide you or not. We hope that our article is helpful for your next IPO decision.

About the Author: Rashmeet Kaur | 18 Post(s)

Rashmeet Kaur is a certified investment advisor. She is aiming to be a financial analyst, and is the one who encourages reading and loves to explore economics and stocks. She loves to discover her own style while writing, and wants to live a creative and adventurous life. 

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