25th February, 2022
Buying stocks is considered the fastest way of accumulating wealth, and it is true to a large extent. But stocks are also one of the fastest ways of losing wealth, especially if you take excessive risks.
Investing in stocks involves many risks, be it rising inflation that hits a company’s margins, or declining revenue growth or just bad corporate governance. Eventually the buck comes down to what kind of stocks you bought and did you do any research before buying them.
The risks are comparatively higher in an unlisted market compared to listed one, when you don’t do your due diligence before buying shares as information about companies is scarce. And, if you invest in the wrong stock, you may stand to lose.
In the recent one year, there are few examples where investors have burnt their hands when they bought a stock at a high price in unlisted markets and the value of their stake dropped drastically once they debuted on the exchanges.
Three names stand out: Payment solution provider, One 97 Communications Ltd (Paytm), insurance policy distributor, PB Fintech Ltd (Policybazaar) and cash management service provider, AGS Transact Technologies Ltd.
Before the company announced its IPO (initial public offer) price band,
Paytm shares traded as high as Rs 3,500 in the unlisted market thanks to its much hyped publicity of being the largest IPO ever and a euphoria created around the issue.But when the company announced the IPO price band (Rs 2150), it was at two-third of the prevailing price, puncturing the valuation bubble.
The prices further plummeted when the stock got listed on the bourses, as the market price discovery found even IPO price too much to digest.Today, the stock trades around Rs 810, one-fourth of the price it hit in unlisted markets, just before stock market listing.
A similar story played out with PB Fintech.
The market was rallying. The company raised money at heightened valuations in the past. The business outlook was not looking bad. The management, and the market community also built a rosy narrative around the stock sending prices to as high as Rs 1,800 in the unlisted market.
However, the IPO price (Rs 980) was announced at half of the prevailing prices. When it got listed, prices initially rose a little but then eventually came crashing down.
It now trades around Rs 730.
AGS Transact Technologies, which got listed in January 2022, has also eroded wealth for those who got trapped at a high price of Rs 600 in the unlisted market just before its listing.
The IPO price for the scrip was Rs 175 and it now trades around Rs 104, one-sixth of the peak unlisted market price.In hindsight, one can say that people should not have invested in such loss making companies, and since they did, their fate was sealed.
But, in real time when market optimism is at peak, even experienced investors can be trapped in such investments.In order to lower the chances of being stuck in such investments, you need to understand what mistakes investors of these companies committed, so you do not repeat them while doing the investment in big companies like HDFC Securities Shares.
Poor Price Discovery
The biggest issue with unlisted markets is that the daily trading volume is very low, with participation mainly limited to savvy investors.
Moreover, the information available on companies is limited, making it difficult to value them. In such a case, even mildly positive or negative news can have quick and unreasonable reactions in the market.
And, unlike the listed market, there is no circuit limit in the unlisted market.
All these factors make price discovery extremely difficult.
So, what should you do?
Valuation experts believe a stock trading in the unlisted market should be at 10-30% discount to what it would trade in the listed market.You can compare the valuation of the stock in the unlisted market to its comparable peer in the listed market, apply the valuation multiple to the unlisted stock, and then discount it to estimate its intrinsic value.
If the prevailing price is substantially higher than your intrinsic value estimate, then wait and avoid investing. (Read more about how to value unlisted shares)
Lack of due diligence
Another mistake that investors commit is that they do not do their own research and due diligence.
In the unlisted market, where companies are not duty bound to release any price-sensitive information to their shareholders, doing due diligence becomes even more crucial including checking company financials, business growth trajectory, its valuation history and track record of management.
Lately many companies that came out with IPOs had a large ‘offer for sale’ component.
It basically means existing shareholders are looking to exit the company. In order to maximise their benefit, IPOs of such companies are almost priced to perfection, leaving not much growth for new retail investors.
So if you are investing for a long term just before the IPO, your post listing gains may be limited. To minimize your risks, find out if a company has a lot of venture capitalists or institutional investors looking for an exit. Such stock should be bought with caution or sold quickly to book listing gains.
Often we buy shares because some friend or relative says they are sitting on big gains in some shares.
Sometimes a ‘tip’ can come from forums or message groups you are active in. It seems like everyone is making money except you.This creates fear-of-missing-out (FOMO) and you end up buying shares that have already surged too much and too fast.
This herd mentality leaves you trapped in an investment. Make sure you take a pause and understand all aspects rather than rushing to buy a share by looking at these tips.
Tell us in the comments section below, what lessons you learnt from investing in unlisted shares.