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Choose listed companies over new offerings

With a majority of stocks in the past decade quoting below their issue price after listing, the secondary market might be a better bet for investors

Ashley Coutinho 

The secondary market has seen an uptick in the past year and a half. The primary market is now showing early signs of revival, with as many as 12 companies filing initial equity offer documents with market regulator Securities and Exchange Board of India (Sebi) last month. Add another 10 that already have Sebi approvals and initial public offerings (IPOs) worth at least Rs 9,000 crore could hit the market this financial year.

More IPOs might not necessarily be a good thing. A recent research report by proxy advisory firm IiAS states investors would have lost money in about 60 per cent of the IPOs in the past 10 years had they subscribed to these. It says IPO investment is akin to rolling a dice.

Listed firms better than IPOs
That might seem a bit of an exaggeration but investors might indeed be better off sticking to listed firms in the current market environment. In general, say market watchers, investors should avoid IPOs when the secondary market is buoyant and subscribe to these when the market is sluggish, although there are likely to be far fewer opportunities to invest in IPOs during these periods.

"When the sentiment is bullish, euphoria takes over and promoters tend to overprice the issue, leaving little money on the table for investors," says Feroze Azeez, executive director and head of investment products, Anand Rathi Private Wealth Management. Agrees Anand Tandon, an investment analyst: "In an IPO, it's an insider selling shares to an outsider. The promoter will try to extract the full price, so how can the offer be in your favour?"

Experts feel investors are likely to get a better price in the secondary market, despite the market appearing a bit frothy now. "With corporate earnings expected to improve in the coming months, I would recommend investors stay invested and take fresh exposure with a medium- to long-term horizon of three to five years," says Rajesh Cheruvu, chief investment officer, RBS Private Banking, India.

According to Azeez, valuations are bound to remain at elevated levels in a bullish market and investors should not focus solely on valuations to pick the right stocks. "If investors wait too long for the markets to correct, they might miss the bus," he says.

Cheruvu recommends investors put more than 80 per cent of their equity portfolio in large-caps right now, as these offer a higher margin of safety vis-a-vis mid-caps and small-caps. He is bullish on interest rate-sensitive banking, automobile and consumer durables stocks, as well as information technology (IT) firms. And, believes investors can set aside 50-60 per cent of their fresh in these sectors.

"A couple of more rate cuts are expected in the next 12-18 months. The monetary easing will benefit banks as credit growth improves and asset quality issues recede. Auto and consumer durables will benefit from improved consumer demand, while the IT sector will benefit from the recovery in developed markets such as the US and Europe," says Cherevu.

Right IPO strategy
It would be unwise, though, to give up completely on IPOs. "Good IPOs will make money. With better information disclosure and tools such as IPO grading to fall back on, investors are in a much better position to assess their quality now then 10 years ago," says Rikesh Parikh, vice-president, equities, Motilal Oswal Financial Services. Indeed, four of the past seven IPOs (excluding INOX Wind) are in the money.

According to Prithvi Haldea, founder of PRIME Database, it is unfair to paint all IPOs with the same brush, as every company is distinct. "Because 60 per cent of the IPOs are quoting below their issue price in the past 10 years does not mean every investor who has put money in these firms has lost money," he says, noting that several investors would have exited with listing gains or booked profits at different time periods.

It's not the IPOs but the investors who are at fault, he adds. "IPO investors are often taken in by greed and do not have an exit strategy in place." As a general rule, investors should only look at companies with a competitive advantage in the area they operate in, have a good record of corporate governance and profitability, and quality management in place.

Azeez says investors should look for a margin of safety by investing in IPOs offering a 20-30 per cent price to earnings discount to listed peers. "Do not invest if the IPO free-float is more than 30 per cent of the total market capitalisation of the company. If the free-float is too large, price rises tend not to sustain," he says.

The other common mistake is to invest in IPOs for listing gains alone. "While the percentage of listing gains might seem large at times, the absolute returns are likely to be relatively small in most cases. Stay invested for a year or two, giving time for the business to grow," says Azeez.

First Published: Sun, April 12 2015. 23:19 IST