Is SEBI’s strictness a sign for you to become cautious on SME IPOs?

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Market regulator SEBI has come up with new rules for investor protection. These are primarily around small and medium enterprises, meaning it will be implemented on the SME segment. Under these new rules, Additional Surveillance Measures (ASM) and Trade to Trade (T2T) regulations will now apply to companies in the SME segment. This decision was made after deliberation with stock exchanges. Previously, these rules only applied to mainboard companies.

Why did SEBI implement these new rules? Is this a warning for SME companies? Let’s find out. 

ASM, which stands for Additional Surveillance Measure, is a method or measure of additional scrutiny placed on shares. ASM is an initiative by the stock market regulator SEBI and stock exchanges. It is implemented to safeguard the interests of investors.

ASM concerns are based on parameters like price, volume, and volatility changes. There are two types of ASM: Long Term (LT-ASM) and Short Term (ST-ASM).

Now let’s understand why a stock is included in the ASM list.

Being included in the ASM list means that the exchange is warning investors about unusual price movements in that stock. This step aims to reduce or control the volatility in that particular stock. Now, let’s delve into the T2T framework. T2T, or Trade to Trade, is a regulatory framework. It is used to monitor and control the trading of shares, especially those with excessive speculation or illiquidity. In the T2T segment, trading cannot happen, meaning you can only either buy or sell in a day.

Now, let’s find out why these new rules have been introduced:

This year, in 2023, SME company IPOs have gained significant traction. A total of 135 SME company IPOs have been listed, while in the mainboard segment, which includes larger companies, only 33 IPOs have taken place. Since its inception in 2012, SME companies have raised the highest amount of funds in a year.

In the past decade, since its inception in 2012, the BSE SME Index has seen an approximately 350-fold increase. Despite several years of rapid growth, this index has surged more than 2-fold in just the past year.

Furthermore, in recent months, several IPOs of SME segment companies have received a tremendous response.

Companies like Madhusudan Masala, Basilic Fly Studio, Drone Destination, Oriana Power, and Hi-Green Power have garnered significant retail investor enthusiasm. Arun Mantri, the founder of Mantri FinMart, believes that there is significant speculation in SME company stocks because they tend to be illiquid and often have no circuit limits. With the implementation of new rules by SEBI, such speculation may decrease. It’s possible that more regulations may be introduced for this segment in the future.

Now, the question is, whether investing in SME company IPOs is an easy and cost-effective path to success or a market filled with speculation.

According to Arun Mantri, it’s not that all SME segment companies are bad. About 5-10% of these companies have strong fundamentals. However, achieving returns similar to those seen in the past 3-4 quarters may be challenging in the next 3-4 quarters. In the next week, 10-12 companies are coming up with their IPOs, indicating that companies want to capitalize on the euphoria among retail investors. Ideally, retail investors should consider investing in IPOs of mainboard companies or large-cap shares.

If you are determined to invest in SME companies, consider three key factors: a long company history, profitability, and a sector with earnings visibility for the next 4-5 years.

Overall, not all SME companies are bad, but only about 1 in every 10 may be a good investment. Therefore, don’t invest in any company blindly, especially based solely on the IPO market’s enthusiasm.

Before investing in any SME company’s IPO for the next 3-4 quarters, exercise extra caution, as regulations may become stricter.