Free Press Journal

Decoding the right time to invest in IPOs


Positive sentiment and strong market are the harbingers of an IPO rush, and companies too tap the IPO market to get the true potential value for their shares. However, investors have to be wary of companies they choose to invest in, advises A. L. I. Chougule

Did you miss the Avenue Supermarts (D-mart) Initial Public Offer windfall? Those who applied and were lucky to get allotment will not forget the 114 per cent listing gain it delivered. But such super premium listings are rare. Don’t fret if you have missed the IPO bus so far. There is not going to be dearth of opportunities coming your way in coming days and months as favourable market conditions have raised the confidence among businesses to tap the primary market. In FY 2017-18, the market expects the IPO rush to continue; various estimates put the figure in the range of Rs30,000 to 40,000 crore.

Good choice
IPOs are one of the best ways to invest as well to get a pie of the equity market. For businesses, it is the best way to raise capital from public for future expansion as well as to lighten or retire debt. IPOs not only bring existing or new businesses to investors’ notice but also help discover true value of a company or business.

There are two kinds of markets: Trader’s market and investor’s market. A trader’s market is one which moves within a narrow range and lacks definite direction. Often bearish market behaves like a trader’s market. Not only it suppresses demand but also kills appetite for fresh paper. No company or business will come up with an IPO when the market is underperforming as lack of demand for new paper will affect price discovery. It is why the IPO market dries up when market conditions are unfavourable. That’s what happened between mid-90s and late 90s, in early 2000s and for a couple of year post-2008 recession.

On the other hand, bull market is an investor’s delight. As market sentiment gets upbeat, not only people invest in secondary market but also participate in IPOs in a big way, which often results in oversubscription. It is the prime reason why businesses and companies ride on the momentum to tap primary market as they believe they can get the potential value for their shares. Sometimes the IPO market gets so good that investors are spoilt for choice.
The IPO season

Another important indicator that augurs well for IPOs is a sustained rally in mid-cap stocks. What’s even better for a flurry of primary issuances is premium for mid-caps over large-cap stocks. It is currently the case with benchmark indices at near new highs. In the last one year, for instance, while the BSE benchmark index has risen 16 per cent, the mid-cap has gained 24 per cent in the same period. This indicates confidence in valuations as well as more appetite for fresh paper at higher valuation.

While companies see this as great market opportunity, investors not only have to be selective but wary of companies they choose to invest in. For, not all companies that hit the IPO road will have strong business model or track record of consistent growth. It is important to understand that rarely an IPO has everything going right for it. In some cases the fundamentals of the company may not be good, while in others the promoters do not give investors confidence. In some cases, it could be the case of a sector as a whole going through a difficult phase. Sometimes the valuations are too expensive. It’s difficult to find an IPO where all these parameters are met. Avenue Supermarts was an exception.

Do the maths
There will always be at least one negative. But that should not stop you from taking a call on good initial public offerings. So what you need to know before you apply for an IPO? Quite a few things and they all are important for betting your money on a piece of business.

The first thing you must do is study the issue details like the size of the IPO, price band and the aim of the issue. That is, how the money raised through the IPO will be utilised – whether it is for retiring the company’s debt, future expansion and or for general corporate purpose and in what proportion.

The second, and very important, point on your checklist should be the company’s financial performance – its top line (gross revenue), bottom line (net profit), any stress in balance sheet, debt to equity ratio, net worth and return on capital employed. The third important point is valuation check – earning per share, price to earnings (PE) multiple the IPO is priced at and whether the premium is justified vis-a-vis the industry PE.

Growth drivers and future prospects are the fourth and fifth checklist points – robustness of business, its key drivers, seasonality aspect, competition, margins and the performance of sector as a whole. The differentiator – what differentiates the company’s business from its peers and the advantages it has over the competition – is the last point you should check before taking a call on an IPO. These are all fundamental checks. Though at the end of the day fundamentals count a lot, market does not function on fundamentals alone. It is also driven by sentiment.

Whenever the market grows stronger, it is driven by both fundamentals and positive sentiment. When the market is supported by both, the possibility of an IPO rush is not only high but the possibility of IPOs commanding premium also goes up. For instance, at Rs. 299, the PE multiples for Avenue Supermarts was 39. The valuation was expensive but it was lapped up by investors because of strong fundamentals. It is another story that the share is now trading at highly stretched valuations of 70 PE multiples. Apart from Avenue Supermarts, many companies that did their IPOs in last fiscal were well-managed companies and hence gave significant returns.

But not all businesses can be same and hence it is important to separate the wheat from the chaff. So be choosy and pick the cherries. But you cannot identify cherries without studying the fundamentals. Equity investments, as the warning goes, are subject to market risk. Be informed first and then decide.

Forthcoming IPOs:
There are 14 firms under Sebi’s evaluation for IPOs. The list includes National Stock Exchange (NSE), Nakshatra World, Bharat Road Network, GTPL Hathway and Tejas Networks. Panache Digilif which opened recently will go on till April 17.