Should You Invest in Upcoming IPO’s

This has always been seen that, whenever markets move positively, the Initial Public Offers also flood in before investors. Obviously, the key to getting fully subscribe depends on positive emotions in the stock market. But sometimes, the investors do not get the desired profits as they invest in companies who have just come to IPO market to fund themselves and not increase the shareholder’s revenue or sometimes the investor exits too soon, without giving proper time to generate profits.

Let’s start by understanding IPO. We all know that share market is one of the ways, by which new or already listed companies can get capital for new projects, or to fund existing projects or for any specific objective like retiring debt or free promoter’s holdings.

An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but they can also be done by large privately-owned companies looking to become publicly traded. When an already listed company brings such issue it is called FPO or follow-on public offer and when it is offered to only exist, shareholders, it is called Right Issue.

This is relevant more as this year we have seen 22 IPOs till 31 Oct in 2016. Few large companies like Vodafone India, Varun Beverages, SBI Life Insurance and International Tractors are waiting to tap the IPO market.

The Hindi version of this article was published in Dainik Bhaskar on 25/10/2016. This is a link to the article.

First of all, an investor should know that IPOs do not give you any fixed returns or even guarantee your capital. Many stock brokers and agents dealing in IPOs do not explain the risk involved. On the other hand, they try to collaborate stories using superficial demand figures and profits generated from past IPOs. All IPOs are different as the company bringing the IPO are from different sectors.

IPO investing is equivalent to investing in share markets. The stock price movement can be highly volatile and the only way to smoothen volatility is investing for a long time.  A well-chosen IPO, like HDFC Bank or Infosys, can be investments which would make you wealthy if you simply make the right choice and stick with the stock for years. So money earned just after the listing of IPO or selling the allotment in gray market is not an investment- it is pure speculation or gambling.

Benjamin Graham who is credited with inventing value investing has described IPO as- It’s Probably Overpriced, or Imaginary Profits Only, or Insiders’ Private Opportunity, in his book Security Analysis.

These are the top main reasons you should not be investing in and IPO:

• Overpricing: The IPO is an exit route for existing promoters, venture capitalists, and financiers. Keeping the price high is in their interest but you should check if the price they are asking is justified or not, The best way is to check the companies in similar business line and with the same
• Management quality: This is applicable for all transactions in share market. The integrity, honesty, and track of managements is very important. Many owners with the objective of just filling their pockets often hit IPO markets taking advantage of good sentiments. These fly-by-night owners are just interested in their own money and not shareholders
• Avoid the Hype: It’s important to understand that agents are salesmen. The companies also sometimes intentionally hype up to get as much attention as possible. Since IPOs only happen once for each company, they are often presented as “once in a lifetime, listing gains, long-story” kind of opportunities. Don’t buy a stock only because it’s an IPO – do it because it’s a good investment.
• IPOs are cheap hence outperform their peers is a myth: A key part of the IPO narrative is that they offer something, new, fresh, a new idea or a breakthrough and somehow better than what is out there with existing companies. The IPOs are fairly priced and a lot of mechanics is involved in funding a current offering price range.
• Always read the prospectus: You should never skip reading the prospectus. It may be a dry and long read, but the prospectus lays out the company’s risks and opportunities, along with the purpose for the money raised by the IPO. Taking an example, if the money is going to repay loans, then look out! It is a bad sign if the company cannot afford to repay its loans without issuing shares.

• What if this business does not grow at a high enough rate as mentioned in the prospectus, to justify its price, what is the likely cause? What are the probabilities of those failures occurring? What are the risks?
• What are the competitive assets that business has an advantage? Brands, Market Share, Patents, Trademarks, Key Executives?  What is stopping another firm from coming in and copying what this company is doing?
• Would you be comfortable owning this share if the stock market were to close for the next five, ten, or twenty-five years? In other words, is this business model and the company’s financial foundation sustainable or is it just new technological advancement or a new fashion? Will the company product stand for years to come?
• If the stock falls below its offered price a will you be able to continue holding without any emotional response if you can conservatively determine that the long-term potential of the business still remains promising? You believe the company will stand in coming years?

Finally, realize that the odds are placed against you. IPOs, as a class, do not perform very well relative to the market. They’re often priced and act as an exit route for initial investors. Not all IPOs are bad. But you must invest if the offering is rightly priced and you are willing to make that scrip part of your portfolio for a long time.

Share your views and comments below.