Why Applying for Every IPO Is a Bad Strategy?

One of the biggest misconceptions is that all IPOs deliver high listing gains. Data from recent market cycles show that while some companies debut with impressive premiums, many others list at modest gains or even at a discount. The higher risk is probably found in those issues that have received excess hype, regardless of the strength of the relative valuation.

A primary concern in terms of applying for every IPO is the valuation that the companies list. During bullish cycles, numerous companies are aggressive in pricing their shares, providing little dilution for new investors. High valuations based on optimistic estimates of the future are generally not sustainable once the company is in public trade.

While applying to every IPO may seem to mitigate risk, financial professionals will tell you that it does just the opposite.By holding many unrelated stocks with weak fundamentals, you reduce the overall quality of your portfolio.

In high-volume IPOs, retail investors can have an extremely low probability of being allotted shares at all if the deal is oversubscribed. Additionally, applying to every IPO ties up your funds (sometimes multiple times), leaving you with no money to invest if you do happen to receive an allotment.

Another way retail investors approach IPOs is that they will apply for shares only because they want a possible gain on the listing day. Market conditions can shift quickly between an IPO announcement and its debut, significantly affecting pricing.

Being a regular IPO investor also likely leads to a high volume of selling. Gains on shares sold within one year of IPO are considered short-term capital gains, subject to a 15% tax.

Fundamentals are the basis of a company's value, including its products, revenues, profits and other aspects of its operations. Thus, solid fundamentals indicate that the company is likely to continue to perform well in the future.

The growth potential of a company is an important indicator of its future performance. Therefore, if a company has high-growth potential, this usually indicates that it will generate greater returns over the long term.

The stability of a company can be determined by the debt, cash flow, and profit potential of the company, and if a company has strong financials.

Competitive position is a measure of how well a company is positioned to defend its market share against competitors. Companies with strong brand names, technological prowess or cost advantages typically have a higher probability of being able to endure long-term survival.

The integrity and track record of the founder or owner (i.e., the executive leadership) of a company, as well as their commitment and dedication to the company, will help reduce risks associated with corporate governance.

A stock's valuation can be determined by comparing its earnings, assets, or competitors, and by determining whether a stock's price is fair relative to its fundamental value.