Should you catch the IPO fever?

Look at key parameters like pricing and valuation, compare with sector averages and avoid playing the listing game

There are two reasons retail investors enter any initial public offering (IPO). One, to invest in a good stock such as Coal India in which they want to stay invested for the long term. Two, the riskier proposition, for listing gains. The latter, most financial planners and market experts say, is often not worth it. Nor can it be played for too long.

"The quality of companies which go for IPOs in the initial phase of the rally is still better. As valuations increase, there are companies which will often overprice their issues and investors trying to play the listing game get stuck," says an investment banker, who advises retail investors not to go for listing since it is a game played by big players with large coffers.

In good times, an investor can make 50-60 per cent listing gains in one or two offers. But, if he gets caught in a bad stock or company, he will lose all the money.

The good news is that the listing gains fever doesn't seem to have caught on still, as retail investors haven't been bitten much by the IPO bug, till now. Since the beginning of the year, 21 issues have hit the market. Retail investors have been aggressive with only a handful -- the retail portion of only 13 issues were subscribed fully and only six by over two times. Some of the issues were of small- and-medium-companies as well, in which the minimum investment for retail investors is Rs 2 lakh.

More action is expected in the coming months as well. As many as 15 IPOs have been readied in the next few months. And, the government is planning a number of issues, mostly follow-on, to meet its divestment target.

With the BSE exchange's Sensitive Index or Sensex, and the National Stock Exchange's Nifty comfortably over 27,000 and 8,000 points, respectively, more companies would be interested in raising money when the going is good.

Beside listing gains, if you want to genuinely invest in an IPO, how do you go about it? "The call will have to be based on a case-to-case basis, by using parameters like pricing and valuations with the industry average," says investment consultant Gul Tekchandani.

How does one compare pricing and valuation like the price-to-earnings (P/E) multiple? Tekchandani advises looking at reports that will give these parameters. And, if the company is pricing itself too high, it is better to avoid it.

For example, Inox Wind's valuation can be compared with the capital goods industry average P/E multiple of 30.7 times. Or, Lavasa Corporation and Naysaa Securities with the real estate sector's average of 28.7x and the stock broker/commodity broker's sector average of 15.33x. Depending on the numbers, one can decide. An attractively-priced IPO has a good chance of getting strong response from investors.

However, some like financial planner Suresh Sadagopan have a completely different view. He feels investing in IPOs might not really make much sense. "Unless there is a company which is completely unrepresented in the market place, why should one go for IPOs? Say, if a company in the defence sector is being listed, one can still look at it. Otherwise, investing in the IPO of another automobile component company might not help," he says. Consequently, he does not include investment in IPOs in a financial planning portfolio unless there is a compelling reason to do so.

Quite a few other financial planners agree. According to one, since the stock is going to be listed anyway, one can wait for a few months to see if it will do well or not. After that, if the pricing or valuation holds, one can always buy it from the secondary market. Amit Trivedi, financial planner, says retail investors should, by and large, avoid IPOs completely. "Unless he has the expertise to decide which IPO is good or bad, he should take the mutual fund route."