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Explained: Should you invest in an IPO?

IPO Investment: Bull run in markets has led to companies lining up for initial public offerings. But there are many factors to consider before investing in them, and experts advise retail investors to be cautious.

Written by Sandeep Singh , George Mathew | New Delhi | Updated: December 15, 2020 3:19:24 pm
The IPO market is expected to witness some interesting names, including the mother of all IPOs, Life Insurance Corporation, and the NSE, in the coming months. (Representational image)

Amid a bull run on the stock markets, the initial public offering (IPO) market, or primary market, is again in the spotlight. At a time when companies are lining up to raise funds from the market amid high valuations in the market, one needs to consider several things before investing their money in an IPO.

Why are companies lining up for IPOs?

The IPO market is expected to witness some interesting names, including the mother of all IPOs, Life Insurance Corporation, and the NSE, in the coming months. Others include Kalyan Jewellers, Esaf Small Finance Bank and Barbeque Nation. The biggest factor driving companies to the IPO market is the bull run in the stock markets, which has taken the Sensex to an all-time high of 46,000. A strong market means a good company can get a good valuation for its shares.

It has also enabled several venture and private equity funds’ exit from companies that they funded through the IPO. Market regulator Sebi has fine-tuned the primary market norms, enabling the issuers to float an IPO and list shares in a short period, thus cutting costs. The success of IPOs has prompted many potential issuers to look at the primary market for fund raising and listing as investor sentiment is positive.

ipo, ipo investment, ipo investment india, ipo market, investment in ipo, what is ipo, ipo investment strategy, ipo companies, ipo companies india, how we invest in ipo, ipo investment benefits Source: Prime Database

How have IPOs performed?

Most of the IPOs that raised funds this year have performed well. Rossari Biotech (issue price Rs 425) has gained 13.34% to Rs 841 from the listing day price on July 23. Gland Pharma (issue price Rs 1500) has soared 26.5% to Rs 2,302 in less than a month. Route Mobile (issue price Rs 350) gained 83,25% at Rs 1,193 from Rs 651 on September 21. Eleven companies have raised funds from the IPO market in 2019-20 so far, and all of them were quoting above the issue price as on December 8, 2020.

This performance is over a short period (3-4 months) and it has been supported by a sharp rally in the large-, mid- and small-cap indices. By and large, unlike in earlier years, only companies with good promoters and governance base are venturing to the primary market, and it has also been a result of stringent regulation.

What should you look for before investing?

It is important to take a careful look at the company before you invest. Besides the finances of the company (at least three years), prospective investors must also look at the quality and stability of the management, and the promoters and their credibility.

A good peer review is a must: Investors must study other listed companies in the sector and compare their growth, and also compare their PE ratio (market price to earnings per share). If the company is demanding a higher valuation, investors can choose to skip the issue.

Many experts, however, feel that retail investors should stay away from IPOs. “IPOs are one of the riskiest asset classes to invest in, and ideally retail investors should stay away. Unlike listed companies where there is higher disclosure and information available in public, very little is known about an unlisted about-to-IPO company, in comparison. However, if someone is very keen on investing, then besides studying the company and promoters’ track record, one must also look at existing institutional investors such as private equity and venture capital investors in the company,” said Pranav Haldea, MD, Prime Database.

Should you chase an oversubscription?

It is important for investors to look at the subscription by qualified institutional buyers for the IPO, as that gives an idea of the quality and pricing of the issue. While a very low level of subscription would mean institutional investors do not see the issue as a strong proposition, a high level of oversubscription would mean huge retail subscription and very little allotment, making the exercise futile.

While a retail investor can apply for shares worth Rs 2 lakh in an IPO, if the retail subscription level is 50 times, it would mean the investor would only get shares worth Rs 4,000. Experts feel that putting in so much effort and blocking Rs 2 lakh for 10 days is not worthwhile if your share allotment is worth Rs 4,000.

If you look at the recent issue of Burger King, the retail portion of the issue has been oversubscribed 68 times; that means retail investors who applied for a maximum of Rs 2 lakh would only get shares worth around Rs 3,000.

Also, one must avoid chasing the stock after a strong listing. The listing gains could often be on account of huge oversubscription — when a large number of investors sell their allotted shares within a week of listing, the share could go below its issue price. Industry insiders say the huge oversubscription in case of several issues is on account of high net-worth individuals borrowing from the market, investing large sums in the IPO, and most of them selling the shares on the listing day. Investors must wait for a few days to understand the company and investor interest post-listing. 📣 Follow Express Explained on Telegram

Should you go for a high-priced IPO or look for existing listed entities?

Market experts feel investing in IPOs is no longer a worthwhile exercise for retail investors, who should instead look for fundamentally strong, established companies in high-growth sectors. “Nowadays companies don’t leave anything on the table for retail investors and go for maximum possible valuation.

Also, in case of issues that see high subscription levels, investors get few shares in allotment and that is not worth the effort and blocking of investment for 10 days. Instead of lining up for IPOs, investors should look at companies with strong fundamentals in growth sectors and invest in them,” said C J George, MD, Geojit Financial Services.

Retail investors must also understand that nowadays investment bankers compete for the IPO mandate, and the promoter/company goes for whichever banker gives the highest valuation. As such, there is not much they leave for the investors. So, a high valuation means the IPO would be priced at a premium. It is also one the reasons why there is a flood of IPOs when market valuations are rich — as investment bankers can then push for higher valuation of the IPO.

Why are IPOs important for stock markets?

While IPOs may not be an ideal option for retail investors, they are very important for the broadening and depth of the market. A higher number of good-quality listed entities offer more options for investors in the secondary market, and provide stability and increase liquidity. Consider: If a large sum of investor money chases few quality stocks, they will all turn very expensive and push the stock much ahead of its fundamentals. However, if the same money chases a higher number of good-quality stocks, they are more evenly priced and risk levels are lower.

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