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Invest in IPOs with caution

Tania Kishore Jaleel  |  Mumbai 

More than half of the issues launched this year are trading 20-60% below issue price.

With the government planning to go ahead with the disinvestment process, the initial public offer (IPO) and follow-on offer (FPO) market is expected to take off in a huge way. Companies such as SAIL, ONGC, IOC and Hindustan Copper are waiting to hit the markets. More than hundred companies have filed their draft red herring prospectus (DRHP) with the Securities and Exchange Board of India, the market regulator.

Retail investors, however, need to be careful before they jump onto the IPO bandwagon. Reason: Eight of the 15 IPOs launched this year are trading 18-60 per cent below their issue price.

  • Invest in industries that you are aware of or are tracking
  • Compare the issuing company with its listed peers
  • Quality of the management and corporate governance are very important
  • Look at the firm’s growth prospects and look out for non-regular income boosting the bottom line

Jagannadham Thunguntla, head (equities), SMC Global Research, cautions retail investors to stay away from mid- and small-cap issues. “These firms have issues like concentrated promoter shareholding etc,” he says.

Instead, he suggests them to invest in public sector companies. According to him, though you may not get immediate returns in a PSU offering, you are guaranteed a quality company. One does not know much about mid- and small-cap companies. Thus, it is better to stick to PSU company issuances, as they are backed by the government.

If you want to invest in other IPOs, you can get some clues from IPO grading. For instance, Vaswani Industries, which withdrew its IPO, had a grading of 2/5 from ICRA, indicating below-average fundamentals.

However, IPO grading need not be the only parameter. Galaxy Surfactants is another company which recently withdrew its IPO. But, the issue had been graded 4/5 by Crisil, indicating above-average fundamentals.

“When an IPO is withdrawn, you should look at the reason behind the withdrawal. In a depressed market, like right now, even a good company may find it difficult to raise funds from the market. On the other hand, in a bullish market, even a bad quality company can easily sail through”, says Hemant Rustagi, Chief Executive Officer at Wiseinvest Advisors.

The most important thing to look at when deciding on investing in a public offering is the quality of the management. The reason why experts recommend PSU issues is the government safety that comes with such firms.

“The corporate governance and quality of the management should be very strong. In an FPO, you have a company’s proven track record. However, you don’t have that advantage as far as IPOs are concerned. So, there is a need to be more careful”, says Prashanth Prabhakaran, president (retail broking), India Infoline.

You should also compare these companies with their listed peers and see how they match up. Compare their track records, pricing etc. Along with the IPO grading, a retail investor should also do his homework. “When investing directly into the stock market, one should be very careful. If you are not too sure of the company, you should rather invest in it through a mutual fund”, Prabhakaran adds.

Pricing is an important aspect. The valuation of the issue should be comparable with its peers. However, cheap pricing does not mean the valuations are good.

There are other things to look for as well, including why is the company raising money, the objectives of the issue, its future growth prospects, the level of profitability the company expects to achieve, etc.

Though there is the lure of listing gains for many investors, given the prevailing market conditions, expert say one should be selective when choosing an IPO. Though one cannot avoid all sectors, some like real estate and infrastructure are quite avoidable.

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First Published: Tue, May 31 2011. 00:48 IST