Investors guide. Know these 5 things before subscribing for SME IPOs

With the domestic stock market recovering from the near-term lows hit in June, many are again tapping the market. The IPOs of small and medium enterprises (SME) are back, with six such public issues already open and another half-a-dozen in the next 2-3 days.

In 2022 calendar year so far, over 60 SME IPOs have raised over ₹1,100 crore. The SME IPOs of Cargosol Logistics, Silicon Rental Solutions and Lloyds Luxuries open on September 28, while Frog Cellsat, Pace E-Commerce Ventures and Swastik Pipe will hit on September 29. Vedant Asset is also expected to come out with its IPO shortly. Look at the table below to know more details about the upcoming SME IPOs.

Don't be fooled by returns

The SME companies have names you have probably never heard before the IPOs, but a few have given prominent companies a run for their money in delivering returns. Stocks such as Empyrean Cashews (up 630 per cent), Jayant Infratech (up 450 per cent), Rachana Infrastructure (380 per cent), Cool Caps (368 per cent) and Sailani Tours N Travels (340 per cent) makes for good headlines, but SME stocks, like rest of the market, are not sure-shot bets.

For every stock that has doubled or tripled, there are in some where investors lost over 40 per cent in a quick time. The case in point being Evoq Remedies, Bhatia Colour and Global Longlife Hospital. About one-third of SME IPO stocks this year are trading below their issue price.

In the corporate hierarchy, SMEs are the smallest. While their size does give them the capacity to grow their earnings faster, the ultra-low revenue base and wafer thin profit can lead to financial position turning bad very fast. A bad year for an SME can be difficult for its survival with about 90 per cent of the listed SMEs servicing some form of debt.

All SME stocks don't have unique business

Many bet big on SME stocks thinking they are distinctive in their businesses. But, that is not always true as most of the listed are not in high-tech or unique businesses. If you look at the upcoming SME IPOs, Frog Cellsat is into telecom equipment, Pace E-Commerce Ventures is into children's items, Vedant Asset is into financial services, Swastik Pipe is involved in steel pipes and tubes, Cargosol Logistics operates in logistics sector, Silicon Rental Solutions is into IT equipment outsourcing, and Lloyds Luxuries is into salon services.

If you notice closely, SMEs are often engaged in the commonly found businesses competing with established players. The common-sector SMEs are from the cables, chemicals, auto ancillaries, logistics, hotels, packaging, steel, entertainment, food, FMCG, healthcare & pharma, plastics, finance, IT-Software and trading . Investors think all the SME IPOs would be big money-spinners. Typically, many SME stocks, once listed, are fizzled out. For instance, in 12 SME IPOs, after the debut day gain, the counters are trading below the issue price. Given that SME stocks are high-risk bets due to smaller size, it is key that investors do proper research before subscribing to them.

Pay attention to valuations

Do not make the mistake of ignoring valuations when dealing with SME stocks as the bets are much larger than your usual purchases. In others, you can buy even one share, but this isn't possible in this space thereby ending up investing with lot size ranging from 1,200 to 4,000.

We need to compare valuations with mainboard players, to get good perspective. If you can't use the Price to Earnings (PE) metric due to lower profits or absence of it, utilise other valuations such as EV to PBIDT, Price to Book Value, Market Cap to Sales, etc., to get a broad idea of how the SME stocks stands.

With low liquidity, a small investment by a handful of participants often pushes the SME stock price. In low liquid counters, valuations can change swiftly.

Given that SME stocks are virtually under or not researched at all, the long-term investors should focus more on future earnings potential. Without information, do not become greedy and simply invest on somebody else advise, or some big investor plans to subscribe.

Know SME stock basics

The BSE and NSE have built credible and efficient marketplaces to help SMEs raise capital. But since SMEs often do not have the wherewithal to deal with compliance like bigger firms, some relaxations have been given to SMEs listed on the platforms.

As a potential investor, you should understand these norms. For instance, the SME IPO documents are not vetted by regulator SEBI. It is the exchange that gives observations on DRHP. Next, SME IPOs are 100 per cent underwritten.

Reporting requirements such as audited accounts have to be disclosed every six months in SME platforms compared to three in a mainboard listing.

Also, the requirement to publish results in newspapers, circulation of annual reports and e-voting facilities do not apply to these companies.

Only for patient investors

The SME IPO marketplaces are built as capital formation platform. This is not a trader’s market, even though many feel enthused by the quick gains, etc.

So, if you are investor with a short-term horizon, you must stay away from dabbling in SME stocks. As we understand, the SME IPO space is for investors with the capacity to hold the stock for the medium to long term. For each relaxation provided to SME companies, the risk goes up in investing.

When you play the long game, you may realise substantial gains in the SME stock arena. It is better to have your portfolio dominated by good-quality largecap and midcap stocks. The SME stocks and such IPOs can form only a very small portion in the satellite component of the portfolio.

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