06 December, 2010

Chasing IPOs

Unless you have the means to analyse them, better opt for listed companies.

Chasing rainbows is a pleasure though there may be nothing at the journey’s end. The IPO (Initial Public Offering) game is similar. Investors chase the elusive rainbow and mistake all IPOs to be a pot of gold.

Somehow, IPOs, FPOs (Follow-on Public Offers) and rights issues have a draw with people that is beyond comprehension. The interest may not always merit the returns. Most people, for some reason, assume a public offer of shares has to be cheap and hence a good idea to participate. This is probably a hangover of the past, when the Controller of Capital Issues used to set the price for a public offer and getting an allotment was like winning a jackpot.

Today, IPOs are aggressively priced. For investors looking for listing gains, possibility of a loss is more or less 50 per cent (if you look at, say, the one-year history). In fact, a CARE Research study on the performance of 116 IPOs issued between August 2007 and 2010 indicates that in about 35 per cent of cases, the current traded price is above the upper band of the IPO price, while 62 per cent is below the IPO price. Investing in IPOs should not be the only strategy.

Investors may want to pick and choose between IPOs. But information about these companies may not be available freely, apart from their own prospectus. Not many investors can use information from this one source to establish if the IPO’s price is right, and can make an informed investment decision. If such were their prowess in identifying companies with underlying value, they would be milionaires many times over and need not resort to investing through IPOs anyway. A better strategy would be to choose from among the listed companies, whose performance is known and on whom even more data is available in the public domain.

If, on the other hand, they are relying on the analysis provided by various market mavens, the result can be confusing – for there are divergent and opposite recommendations. During an IPO, one can expect many planted good reviews too. Afterall, the company, their investment bankers, underwriters and the stock broking community are all direct and obvious beneficiaries. So, expect peans being sung in praise of the IPOs.

Most retail investors subscribe to various IPOs based on the ratings given by rating agencies. Incidentally, Reliance Power got rave reviews and even Crisil gave it a 4/5 rating. The stock listed below its issue price and is still quoting lower than its issue price. With the ratings going wrong, investors could end up owning a portfolio of companies without any underlying rationale. If this portfolio is not diversified across sectors, the risk profile increases.

Hope and greed
The other fallacy in investing in IPOs is looking for listing gains. That is gambling, not investing. Losses are as much a possibility as seen in the Reliance Power issue. One reasoning why IPOs seem attractive is because, choosing from among 3,000 companies that are already listed seems a herculean task. In the case of IPOs, the decision making process gets simplified, as there are just the IPO candidates to choose from. In addition, there is nothing to do except read some reviews and make up your mind. Some investors may not even do that – they just follow their friend or colleague who is applying for the IPO. They always find enough justifications for investing in IPOs – foreign institutional investors, (FIIs) are investing, there are enough favourable recommendations and brokers and other intermediaries are optimistic about IPOs.

It may be a far better idea to invest in the existing universe of stocks, about which performance history exists. Even if investors want to invest in stocks that came out with IPOs, they could wait until its listing, give it some time for price discovery and stabilisation. That way, they may even end up buying below IPO prices. Even if the price is up, one could check if the equity is good to invest at that price and then invest. lets remember, the IPO stock will be available even in future. Retail investors could even consider good mutual fund schemes to invest in if the IPO does not live up to its expectations.

Published in Business Standard on 31/11/2010

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