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Don't look for supernormal gains

Investing can be fruitful if one approaches them as 'investments' rather than lotteries

Jayant Pai 

The primary markets have been quite somnolent for the past three years or so. During this period, while institutions have been fairly active in the Qualified Institutional Placement (QIP) market, retail investors have largely been ignored. Now that a revival of the primary market appears to be on the cards, it may be a good time to revisit a few basic tenets of investing in this market.

The primary market largely comprises of two segments : 1. Initial Public Offerings (IPO) 2. Follow On Public Offerings

Worldwide, IPO markets are often viewed as a lottery, wherein successful allottees are able to sell their holdings at a huge premium on listing. This belief may still hold good in some countries, but in India this arbitrage has faded over time. This is due to :

Free pricing of IPOs: Today’s newbies may find the old ‘war-stories’ of fabulous gains from IPOs very alluring. However, sadly for them, times have changed. Prior to 1992, IPOs were priced as per an ultra-conservative formula, which invariably resulted in allottees enjoying super-normal gains. However, since 1992, this formula has been dispensed with and promoters are free to price their IPOs as per market demand. Hence, a lot of value is appropriated by the promoter at the IPO stage itself. Since it is a zero-sum game, the promoter’s gain is the allottee’s loss (albeit notional). Hence, while it may happen once in a while, it is unrealistic to treat supernormal gains as “Par-For-The-Course”.

The dice is loaded against you: Promoters have access to the best investment bankers. It is their job to please their client (in this case, the promoter) and ensure that they get the biggest bang for the buck. Obviously, this means that your interest as an investor is rarely, if ever, taken into account.

Despite these factors, investing in IPOs can be reasonably fruitful if one approaches them as ‘investments’ rather than lotteries. Conduct the requisite due diligence by :

Looking at valuations and not ‘values’ : This may sound strange, but many retail investors actually make decisions based on the nominal value of the shares being offered, rather than the valuations. For instance, one of my friends preferred the Bharti Infratel issue to the CARE IPO as the former was priced at around Rs 230 while the latter was at Rs 750. I had to then explain to him the CARE issue was actually priced more reasonably based on the regular valuation metrics of Price/Earnings etc. Investors make this mistake in the secondary market too, when they prefer to purchase penny stocks merely because of low stock price.
 

IPO PERFORMANCE  SINCE 2008
Stock name Date of
listing
Adjusted
issue price
Closing
price
(%)
Change
5 BEST
Jubilant FoodWorks  8/2/2010 145 1,327.05 815
Onelife Capital Advisors  17/10/11 1,100 779.95 609
Gravita India  16/11/10 25 174.15 597
V-Guard Industries  13/03/08 82 530.80 547
Thangamayil Jewellery  19/02/10 75 323.70 332
5 WORST
Nu Tek India  27/08/08 96 0.82 -99
Raj Oil Mills  12/8/2009 120 3.81 -97
Euro Multivision  15/10/09 75 4.10 -95
Austral Coke & Projects  4/9/2008 19 1.08 -94
First Winner Industries  8/7/2008 125 8.91 -93
Price in Rs

In fact, many a times, IPOs which are made during bear markets turn out to be much better as the valuations are usually at sensible levels. Also, the chances of allotment are higher due to the general apathy in the market.

Undertaking peer comparisons: Today, it is rare to come across any IPO where peer comparisons are difficult to make (although Bharti Infratel was one such). Hence, an investor should always compare the company making the offer, with other listed peers. Only then will one know whether applying for the IPO is worthwhile or not.

If the new company is not markedly different from its peers, it may make sense to apply only if it is offering its shares at a reasonable valuation discount.

Investing in Follow-On Public Offerings (FPOs): This pertains to further equity issuances made by listed entities. Here, the decision whether to apply or not, is slightly easier, as comparisons between the FPO price and the current market price can be made on a continuous basis. Sometimes, poor market conditions may result in the offer price being higher than the market price, due to the time lag between the offer price being announced and the issue opening. In such cases, you could purchase the shares from the secondary market, rather than applying in the FPO, in case you are bullish about the company’s prospects.

A few more general points pertaining to issuances :

  • Do not purchase IPOs for the ‘Listing Pop”. It is vital that one adopts a long-term view, based on the company’s fundamentals, so that one is not saddled with a ‘lemon’ in case market conditions are adverse at the time of listing. In other words, purchase the business and not merely the stock at the time of the IPO. 
     
  • Avoid subscribing to IPOs ‘On Margin’ : This involves you subscribing to the issue by only putting up a small percentage of the total sum, the balance amount being borrowed from “Margin Financiers”. Such financiers have a lien on the equity shares that you apply for. In other words you are leveraging in order to apply for a larger quantity of shares. While it is wonderful if the price rises on listing, the converse could cause you severe financial strain as you would be bound to repay the loan irrespective of the fact that the stock may be trading below the offer price. 
     
  • Do not get swayed by the discount : Many companies offer a small discount to retail applicants at the time of the IPO. While this is good, it should not be the sole determinant while investing. A poor quality IPO’s post-listing price may go far below this discounted offer price too. 
     
  • Do not think you are the smartest : Sometimes investors invest in ‘hot’ IPOs despite the company’s fundamentals being suspect, merely because they ‘are certain’ that they can palm off their holdings at a huge premium post-listing. This is known as the ‘Greater Fool Theory’. However, this tactic can backfire badly, as investors in Reliance Power, belatedly realised. 
     
  • Do not blindly trust the Government : If you believe that only private promoters are out to maximise their gains...think again. The Central Government has a chequered history with respect to the Offers For Sale (OFS) / IPOs/ FPOs conducted in the past. While investors have rejoiced in some cases (For instance, Maruti, Coal India and Oil India), they also have been bitterly disappointed in case of some others (For instance, IPCL and NHPC). Hence the principle of ‘Caveat Emptor’ applies to such issuances as well. 
     
  • Merely because an offering is vetted by SEBI, it should not be construed as SEBI vouching for the quality of the issue.

Today, it appears that we are in the first phase of a new bull market. Currently the IPO market is not very vibrant, but it is expected to get more bubbly in line with the secondary markets. This is a good time for investors to learn from the past so as to eschew grief in the future.


The author is Head Marketing, PPFAS Asset Management Private Limited

First Published: Sun, December 16 2012. 00:12 IST
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