Free Press Journal

Are listing gains too good to be true?

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Nikunj Gandhi gives an insight into how not to get plucked into IPOmania

 The IPO season is in full swing and listing gains are the flavour of the season. Christmas came early this year and Santa has been rather generous to the retail investors, who have made it a ritual to subscribe to almost every IPO that hits the primary markets. The modus operandi is rather simple.

A company opens its IPO for subscription; the retail investor participates in it through multiple accounts of his family members in the hopes that atleast half of his offer volume shall get an allotment. And if the investor is street savvy, then he shall gauge the premium that the scrip happens to demand, from his unofficial sources in the grey market to form a speculated “informed” judgement whether to subscribe to the issue, the benchmark being usually set at a 20% premium being demanded in the grey market.


Then post allotment, on the day of listing, if the scrip happens to soar higher than its offer price, he dumps the scrip pocketing a windfall return on his investment and experiencing the feeling of having possessed a Midas touch lately. So, is this strategy too good to be true?

An IPO is a matter of great pride and is one of the biggest events in the timeline of a company when it decides to go public. It is organised with a big fanfare with adrenalins running really high. Advertisement slots are booked over hoardings, televisions and business dailies, roadshows are conducted across the country, interviews are enthusiastically dispensed by the company officials and the office environment is festooned with a festive spirit amongst all employees. The investors participate with a full gusto which further boosts the company’s confidence. So how is it that a sacred moment like this could turn into harnessing emotions like greed and anguish?

The answer lies in the dreaded Valuations.

It has been historically observed that a majority of the IPOs hit the primary markets when the secondary market indexes are gripped in frenzy. Liquidity runs high, volatility (VIX) becomes stagnant or runs low, new DMAT accounts are opened by the first time entrants wanting to jump on the bandwagon and there’s an overall euphoria in the markets about a better tomorrow. This is when the investor throws caution to the wind about Valuations, a weakness that may be exploited during the IPO season. The companies can get away with any pre-set price band since they know there are people willing to pay for it. Greed prevails over rationality for fostering opportunism around everyone. This is when the things start to get ugly.

The IPOs are listed at really absurd prices which does not justify its financials. The promoters have complete faith in the rising markets for oversubscription to their issue and valuations usually take a back seat. The price bands are set at an alarming PE ratio and book values are grossly ignored. Even the promoters/management may not be competent enough to keep running the business and may be using this opportunity to fund an easy exit by dumping their stakes on unsuspecting investors.

So how does an investor safeguard his interest in this IPOmania?

It’s like the Caveat Emptor clause comes high on steroids for the retail investor. There has to be a realisation that Equity, as a class of investment, is usually long-term. Listing gains are a short-term play and does not usually last. The investors luck is bound to run out sooner or later and it would be too late before he realises that he got stuck with some duds in his portfolio. Blindly relying on grey market premiums or brokers/bankers advise cannot ensure an IPOs success.

So is the case with oversubscription numbers as they may be misleading and suffer from the herd mentality bias. The issue may open with a lower price than the price band and the investor may become reluctant to sell as per his strategy and as the markets realise the company’s true potential, the price may go further south as per the valuations, further mitigating the investor’s losses.

A few questions to ponder over before investing…

Does the company have a sustainable business over a long-term horizon, say even for the next 5 years? Is their trajectory growth oriented? Who are the promoters/management and how does their credibility stand? What are the objectives of the IPO, whether it’s for expansion/growth like acquiring property, technology or is it for paying off some existing promoters looking for an exit, or for servicing working capital needs? How is the IPO priced? Does it command a premium over its industrial rivals and if so, is it justified?
A prospectus or a red-herring prospectus can answer most questions. It can give you an insight on the business model, its policies, the credentials of promoters/management, the objectives of the IPO and most importantly the financials. Brokerage houses bring out reports authored by professionals stating their opinions based on number crunching and market environment. These can be taken into consideration for making an informed assessment of the opportunity at hand.

To conclude, are listing gains a sign of a bubble? Once again, we venture into unchartered territories based on empirical studies. And if history is of any consequence, we are just enjoying an extended bout of beginners’ luck at the Grand Indian IPO Casino! Be careful.

(Nikunj Gandhi is an Equity Investor and can be reached at nikunjgandhi@hotmail.com. These are his opinions and not necessarily of the newspaper’s.)