SME IPO Oversubscription: Signs of a Market Bubble?

Editor's note: Following cautious comments from SEBI chief over the unprecedented rally in the smallcap, midcap and SME segment, broader market indices have suffered a major blow with as many as 800 small cap stocks touching their lower circuit on 12 March 2024.

The BSE SME IPO index suffered the sharpest decline, extending losses and falling over 5% in Monday's trade.

SEBI chief Madhabi Puri Buch said that there were signs of manipulation in the SME segment and that the regulator is working on ways to curb the same based on the market feedback.

The market regulator is also monitoring price manipulation instances in IPOs and said that it may consider implementing disclosures as a starting step with respect to SME IPOs.

Apart from that, the ED's ongoing investigation into whether proceeds from the Mahadev betting case were routed into the small-cap and SME segments have also added to the negative sentiment.

To be honest, many investors saw this coming as valuations concerns were already looming and the rally was purely driven by speculation in many stocks from the smallcap and SME space.

In fact, we even covered a detailed editorial back in December 2023 highlighting that SME IPO oversubscription is showing signs of a market bubble.

Continue reading...

SME IPO Oversubscription: Signs of a Market Bubble?

In the current market chatter, two subjects are dominating conversations - the Indian share market's record run and the strong gains witnessed in recent IPO listings.

While the recent exceptional gains from mainstream IPOs like Tata Tech and Gandhar Oil Refinery are catching everyone's attention, let's take a step back and shed some light on the often-overlooked part of the IPO market - Small and Medium Enterprises (SME) IPOs.

You see, for companies looking to go public, there is no better time than when the market is in a strong bull run.

In 2023, we saw 48 mainboard and 57 SME IPOs hitting the market till date. The SME IPOs, in particular, have become the talk of the town and have caught the attention of investors.

To understand this better, let's look at some examples.

The most recent SME IPO of New Avenue Tech was subscribed as much as 721 times. 721x oversubscription, let that sink in for a while!

And this is not the only SME IPO that was oversubscribed so many times. Recently, Deepak Chemtex, Rockingdeals Circular, Kalyani Cast Tech, and Rox Hi Tech have all been oversubscribed over 200 times.

If we look at the backstory, the SME oversubscription trend has been going on for a while. In the first half of 2023, seven SME IPOs were oversubscribed over 100 times.

From July onwards, things took off as 32 SME IPOs surpassed the 100x subscription mark, gaining even more momentum since early November.

Moreover, the BSE SME marketcap has crossed Rs 1 trillion in valuation.

One big reason behind this surge is the active involvement of retail investors. People like you and me dear reader, are showing a lot of interest in SME IPOs, contributing to these mind-blowing oversubscription numbers.

So, what does this data tell us?

It's pretty simple. Investors are very optimistic for SME IPOs, and there is a good reason for it. The market is in a bull run.

Due to these oversubscription numbers, there's a good chance that these companies will list at a massive premium price when listed.

And guess what? The trend holds true because the stocks that we mentioned above gave exceptional listing gains on debut. For example, Rockingdeals Circular listed at a 125% premium, Kalyani Cast at 99%, Rox Hi Tech at 80%, the list can go on and on.

Clearly, the listing trend shows that the strike rate of SME IPOs getting a higher premium is much more than the mainboard segment.

But, all of this comes with a warning sign.

1. Huge Lock-in Amount

Now we know that retail investors are flocking to the SME IPOs segment looking for quick listing gains.

But these SME IPOs are not like mainboard IPOs as they demand a high minimum investment amount of over Rs 100,000. This is close to tenfold of the typical investment that investors make in the mainstream IPO segment.

So, a huge amount is getting locked-in which poses higher risk for retail investors.

What if the markets crash on the day of the SME IPO's listing? Would it fare well in this case?

We don't know... but we do know that you should not solely rely on subscription numbers and grey market premium (GMP).

2. What if the Markets Peak Out?

There is a popular saying which goes, 'Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.'

If something like this happens, this can be a cause of concern for SME IPO investors.

We know that the performance of an IPO depends a lot on the overall market sentiment. If the sentiment is bullish, there is greater appetite for investment and investors often get trapped in the greed cycle.

If the markets peak out, the current excitement around IPOs and the big listing gains could backfire investors' portfolios and a huge lock-in amount follows high risk.

Hence, investors must keep in mind that SME IPOs can be a double-edged sword... ultimately, you should conduct due diligence before taking a final call.

3. Beware of the IPO Bubble

From the recent SME listings, we can see that investors are pouring a lot of money into small companies. But, there is one thing an investor must take note of. We are talking about a IPO market bubble.

There might be an instance where companies with average fundamentals may get listed equally to a company with strong fundamentals due to the bullish market sentiment and high subscription numbers.

So, as an investor, you must not get caught up in the IPO frenzy but rather study the underlying fundamentals of the company and also look at valuations and how it compares with the listed peers.

To conclude, many SMEs are working on internalising certain core concepts, universal principles, and integrating the technical landscape. 2023's debuts in the SME segment showed some unique businesses that focus on these points.

And if you find one such SME gem, be sure to hold on to it for the long term as long as the fundamentals remain intact.

A good way to select stocks is to look for these parameters, so you could do them for SME stocks as well:

• Stocks with no promoter pledging.
• High promoter stake (preferably above 45%).
• Low debt to equity (preferably below 0.8 times).
• High ROE and ROCE (preferably above 15%).
• Low cash conversion cycle (below 100 preferably) and low receivable days (preferably below 90).
• And of course, also look for consistency in operating profit margins.

As investors ride the wave of SME IPO excitement, it's crucial to consider the potential risks as well.

After all, all good things must come to an end...

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...

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