IPO market heats up: Three things retail investors must keep in mind

October 2, 2020
Julie Watts

After remaining muted for the most part of 2020, the primary market made a strong comeback with eight initial public offers (IPOs) hitting the street in September against just two till August.

Two IPOs—Mazagon Dock Shipbuilders Ltd and UTI Asset Management Co. Ltd—which closed for subscription on 29 September, were subscribed 157.41 times and 2.31 times, respectively. The issue of Likhitha Infrastructure Ltd, which was also scheduled to close on 1 October, has been extended till 7 October.

Excess liquidity because of interest rate cuts and printing of currency by the US Federal Reserve have revived sentiment in the last three-four months with Indian stock markets surging around 50% from the March lows. The interest of retail investors has also been piqued with rising markets. “There is definitely more interest in IPOs from investors these days. This is probably more to do with the current sentiment of the market,” said Harshad Chetanwala, co-founder, MyWealthGrowth, a financial planning and investment advisory firm.

Remember that IPO investing isn’t a simple affair anymore as it used to be in the early 1990s. Issues used to be priced in the range of ₹10-30 and the premium—the difference between the face value and the selling price—was never higher than three times the face value, said Arun Kejriwal, founder, Kejriwal Research, an advisory firm, adding that issues were rarely priced above ₹30. “Also, the demand could be easily gauged by people waiting in queues for the IPO form in banks. There were seven to eight banks around the BSE building (Mumbai), and you could get a sense of how the IPO was doing by taking a 10-minute walk around the area,” Kejriwal added. This was a time when Sebi wasn’t even in existence.

But nowadays before you think about investing in an IPO, you must keep certain things in mind.

Beware the valuation

IPOs are usually launched when there is a market surge, and as promoters aim to limit dilution of value, the valuations are generally at a premium, he added. This leaves little value for small investors. “The IPOs are now a pricing and a marketing issue,” said Kejriwal.

But this was not so earlier. In the early 1990s, IPO pricing was a function of the company’s net-worth and earnings. Rarely was the premium kept higher than three times the face value of the share. This meant that people applying for IPOs knew that there is value on the table.

Astha Jain, senior research analyst at Hem Securities, said retail investors should not go for IPOs that are highly priced, valuation-wise, without taking into account other aspects. “They should avoid issues where company fundamentals are not strong,” she added.

Don’t look for quick returns

Looking to make money through listing gains is not the greatest strategy, as it is fraught with risk. “Investors should know that 80% of the IPOs tend to fail,” said Kartik Jhaveri, director of Transcend Consulting (India) Pvt. Ltd, a financial planning firm.

“Once in a while, you can get a company that performs like a D-Mart or HDFC Life, where you make money, but it doesn’t happen all the time. Maybe one or two out of 10 companies will deliver, and then consistently deliver. Otherwise, most IPOs don’t really work out,” added Jhaveri.

Even if you are convinced about the company’s fundamentals, you need to remember that such investments are not for the near term as you need to give time to the company to perform.

Experts believe that the present exuberance may be getting over soon, at least for the near term, and weak performance of the stock markets may hit the prospects of the upcoming IPOs. “Recently, we are seeing some weakness in the stock market because of global cues, increase in covid-19 cases around the world and political uncertainty,” said Chetanwala.

According to Kejriwal, there’s generally a lag between the secondary market (where the shares are finally bought and sold) and the primary market (where the shares are first listed) and the exuberance in the secondary market has already taken place, and we might be in a correction mode.

“If this trend continues, which is quite possible, then IPO investors need to keep in mind that the listing companies will take more time to deliver results compared with their planned growth,” warned Chetanwala.

The pie may be small

Mrin Agarwal, founder, Finsafe India Pvt. Ltd, and co-founder of Womantra, who doesn’t recommend IPO investing, said that as the allotment for retail investors is usually on the lower side, it doesn’t make a material difference in a portfolio. “Moreover, investors are not able to keep track stock price movements beyond a point and, hence, cannot manage stocks well,” she added.

Other financial planners also advise against investing in IPOs. “Don’t be in a rush to invest in an IPO because as a retail investor you can only invest a very small amount of money. If the company is even decent enough, the IPO will get oversubscribed, and you will get no allotment or a small allotment, which may not be worth your time and effort,” said Jhaveri.

He explained through an example. Suppose you want to invest ₹2 lakh in the stock market. If you take the IPO route, you will be blocking the amount for a few days. Also, there will be no guarantee of allotment or you may end up getting an allotment for ₹10,000-15,000.

However, the waiting period has reduced to about 10 days from about a month or so in the 1990s.

“My advice would be to take your time and evaluate the company and the investment and then make a rational decision, as later on (after the listing), you will be able to buy as much you want,” said Jhaveri.

Investors who are planning to put money in the primary market after looking at the gains in the recent IPOs shouldn’t fall for marketing gimmicks and keep in mind that there are risks and downsides involved. Retail investors would be better off choosing professionally-managed mutual funds for market investment.

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Financial Services Update – October 2020

IPO market heats up: Three things retail investors must keep in mind

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