Warning signs in tiny IPOs

For close stock market observers, the tremendous boom in the IPOs of smaller companies (or SMEs, as they are called) has been raging for some time. This year, a humongous Rs 5,900 crore of fresh money has flown into fresh issues from companies in this size band.
However, the general investing public has noticed this trend only in the last couple of weeks.

As befits the times we live in, this burst of attention came because of the story of an IPO going viral and that of a company that's like the made-for-memes parody of an IPO. A tiny outfit with two motorcycle showrooms on rented premises and eight employees tries out an Rs 11 crore IPO and gets some Rs 4,000 crore of investor interest.

Suggested read: Small is (not really) beautiful

Like every SME IPO excess, people dug up the classic video from the great social satirist and comedian, the late Jaspal Bhatti. If you have not seen this old video, search YouTube for 'PP Waterballs'. The interesting thing is that IPO excesses are not a new phenomenon. I've spent some three decades observing the markets practically every day, and this must be the fifth or sixth SME IPO frenzy I've seen. Every single time, we have had egregious examples of this kind.

In the 90s, a furniture shop in a friend's neighbourhood had an IPO. Soon after the IPO, this entrepreneur (if that's the word to use) bought a Mercedes and a few plots of land and rebuilt his house with Italian marble, and that was that. As for the stock, it sank without a trace.

Suggested read: Character dheela hai

I also had a first-hand view (via an old college classmate) of the workings of a finance outfit whose very business was to rescue failing IPOs of this kind. Earlier, there was a rule that if an IPO did not receive a subscription of at least 90 per cent, the issue would fail, and the money would have to be refunded to investors.

This finance company - whose name was Vishwapriya and whose owner went to jail later in some other matter - would provide temporary finance to such IPOs. The fee was effectively about 20 per cent for a few days worth of financing.

I'm not saying that the SME IPO scene is still like that - but I have no idea. However, in the heyday of the old IPO fevers, the very fact that a small company was having an IPO was a negative indicator of the company. By any conventional measure, the SME IPO phenomenon raises serious questions about the rationality of the current market sentiment and the potential risks for retail investors.

Are we witnessing a bubble in the making, fueled by social media hype and FOMO (fear of missing out)? A while back, the regulator stepped in, issuing a public warning about inexperienced investors choosing the IPOs of high-risk companies without fully understanding the investments. As the frenzy continues, investors must exercise caution and conduct thorough due diligence before jumping on the SME IPO bandwagon.

So, am I condemning all SMEs as avoidable? That's a tricky question. What I have said above does give that impression. However, when I look at the track record of the small-cap indexes and small-cap funds, I can see the problem with such a view that some of my readers may have. After all, every small cap started as an SME. So, where will the champion small-cap stocks come from if investors are to eschew every SME?

Suggested read: The secret of the unicorn

There is no contradiction at all. The problem is in the nomenclature. While the headlines talk of SME IPOs, the companies that raise eyebrows are not SMEs. SME means. These IPOs are TUTE (I just invented that term) - Tiny and Ultra Tiny Enterprises. Many of them, including this bike showroom, are just standalone shops. When discussing established small-cap stocks, we could discuss enterprises with thousands of crores in sales.

So, refrain from investing in these so-called SME IPOs because small-cap stocks are doing well. We are talking about an entirely different scale of company.

Also read:
Not starting to make sense