Pros And Cons Of Investing In SME IPO
Sayali ShirkeCategories: DSIJ_Magazine_Web, DSIJMagazine_App, Special Report, Special Report, Stories
Industry experts have pointed out that the impressive gains in the SME segment often lack fundamental backing.
Are you craving a little more excitement in your investment journey? If traditional options like equity mutual funds and equity feel too predictable, it might be time to consider a venture into the dynamic, highstakes world that’s rapidly gaining traction: investing in small and medium enterprises (SMEs) through initial public offerings (IPOs)
Small and medium enterprises’ IPOs have been buzzing across the markets this year. In 2024 alone, 225 SMEs have made their debut on both the BSE and NSE, with 206 of them listing at a profit and 19 experiencing losses. The odds are intriguing, and the potential for high returns has drawn considerable attention to this space. The average listing day gains from the IPOs of SMEs have almost doubled to 60 per cent in 2024 from nearly 37 per cent in 2023, despite concerns raised by experts and the Securities and Exchange Board of India (SEBI), market regulator.
More stocks have listed with an over 100 per cent premium and fewer have fallen below their offer price on the first day in 2024 compared to 2023. Out of the 206 stocks that listed on the SME platforms of the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) so far this year, 30 have given returns higher than 100 per cent on the first day. Compared to this, 17 of the 179 stocks listed in 2023 gave returns of above 100 per cent on the first day. There were 13 SME IPOs that have given listing gain of more than 200 per cent on the listing day.
Industry experts have pointed out that the impressive gains in the SME segment often lack fundamental backing. According to experts, while these stocks tend to perform well in their early days, it’s challenging to predict when they might start declining. The scale of gains and the quality of companies approaching the BSE and NSE for SME IPOs have raised concerns among both the experts and the SEBI. Hence, experts have cautioned that eventually the stock prices must align with the fundamentals, emphasising the importance of assessing the business model and balance-sheet strength of the SMEs.
For instance, if a stock is trading at a 40 PE multiple, there should be a reasonable growth in earnings, ideally around 20 per cent. SEBI has observed that some SME companies and their promoters may be “resorting to certain tactics that create an unrealistic impression of their operations.”
According to SEBI, these companies might use specific announcements to generate positive sentiment, allowing promoters to offload their shares at inflated prices.
Performance of BSE SME IPO Index
To provide a perspective on SME market performance, a comparison with broader indices is helpful. The BSE SME IPO index, which tracks the performance of SME IPOs, has significantly outperformed the BSE Small-Cap index and the BSE Sensex over the past year. This indicates that SME stocks, as a collective, have yielded better returns compared to their larger counterparts.
This robust performance suggests that the SME market offers a unique investment opportunity, especially for those interested in high-growth businesses that may eventually move to the main board. However, while the returns have been substantial, it is essential to understand that the SME market also carries inherent risks.
Top Gainers and Losers among SME IPOs in 2024
Some standout companies have generated impressive returns since going public, showing the potential for strong gains in the SME sector. The top performers include:
On the other hand, some companies have struggled to keep their initial value. The top five losers are:
Risks of Investing in SME Stocks
Investing in SMEs comes with unique challenges and risks. First, many SMEs have a limited financial history, making it harder for investors to predict their future performance accurately. These companies are often small, with fewer resources, making it difficult to expand quickly and maintain stable finances. Another risk factor is volatility. SME stocks usually have low trading volumes, which means their prices can fluctuate significantly based on the market supply and demand.
Potential Rewards and Tips for Investors
SME stocks can offer substantial rewards, especially if a company achieves strong growth in its sector. Early investment in promising SMEs—particularly in high-growth areas like renewable energy and technology—can yield significant returns. For investors, success in SME stocks requires thorough research. The key areas to assess include the company’s business model, management quality, market position, and growth potential. Diversifying investments within the SME sector can help manage risks by spreading exposure across different companies. A balanced approach, with a mix of high-growth and stable stocks, can also help cushion the impact of market fluctuations.
Frequently Asked Questions (FAQs)
What is an SME?
An SME, or small and medium enterprise, is a business that operates on a smaller scale than large corporations. These companies are often privately owned and have fewer resources, smaller workforces, and lower revenue compared to larger firms.
Can retail investors invest in SME stocks?
Investing in MSMEs is ideal for investors seeking high-growth opportunities and prepared for higher risks. MSMEs often operate in emerging sectors, offering significant growth potential, which appeals to those aiming to invest in innovative businesses early. However, due to the volatility and limited financial history of MSMEs, this investment is best suited for experienced investors with diversified portfolios who are comfortable with fluctuations and can research each company’s fundamentals and prospects carefully.
Who should consider investing in SMEs?
Investors seeking high-growth opportunities and willing to take on higher risks are well-suited for investing in SMEs. It is best for experienced investors with a diversified portfolio who are comfortable with volatility.
What is the revised classification for MSMEs in India?
Since July 1, 2020, MSMEs in India are classified based on two main criteria: investment in plant and machinery | equipment and annual turnover:
- Micro Enterprises: Investment up to `1 crore and turnover up to ₹5 crore.
- Small Enterprises: Investment up to `10 crore and turnover up to ₹50 crore.
- Medium Enterprises: Investment up to `50 crore and turnover up to ₹250 crore.
Methodology
To come up with a list of performing SME stocks, we took into consideration five crucial parameters. The first includes market capitalization. The second and third parameters obtained from the Profit & Loss Account include Sales, Operating Profit and Net Profit. We have also taken into consideration the efficiency of the companies by analysing profit margins. Each parameter was then ranked by awarding it a carefully determined weightage based on its significance, which gives a final ranking of these SME companies. All the raw financial data is sourced from Ace Equity and price-related information is as of November 06, 2024.