IPO frenzy: Here’s how to pick the correct public issue while dodging euphoria

Updated: October 15, 2021 3:14 PM

Applying for shares in IPOs has become easy thanks to the digital process. However, getting an allotment is luck.

IPOIn good times even poor quality businesses demand sky high valuations.

By Niranjan Avasthi 

A trend in markets can be a double-edged sword. There are some who gain from a trend while there are many who may lose from a trend. A case in the point is the recent investors’ frenzy in India’s primary or Initial Public Offering (IPO) market. According to estimates, more than 36 companies have opted for IPOs in 2021. Cumulatively, they have raised over Rs 72,000 crore worth of funds through IPOs. This is much higher than Rs 31,128 crore funds raised through IPOs in 2020. This gives an idea of the tremendous interest India’s primary market has generated among investors. A moot question here is: Have all investors who applied for allotment in these IPOs made money? The answer is No. 

Applying for shares in IPOs has become easy thanks to the digital process. However, getting an allotment is luck and many investors have been searching online for ways and means to improve their chances of getting allotment in a ‘good IPO’. However, those so-called strategies or tricks — be it tracking gray market premium, applying through demat accounts held by each family member, applying in the first hour of IPO opening — seldom work in a highly unpredictable IPO market. Many times investors end up investing poor quality stocks.

For those who were not investing in CY2007 bull market, here are a few important lessons. There are studies that point out that chasing momentum blindly does not work. It is estimated that 25-30 per cent of companies listed in 2007 bull-run are either delisted or suspended for trading. A trend which deserves special attention is only 20-23% of those companies which got listed in 2007 gave positive returns. This shows that following a flurry of IPOs may not always be rewarding. 

No wonder, Warren Buffett said it right: “An IPO is like a negotiated transaction—the seller chooses when to come public—and it’s unlikely to be at a time that’s favourable to you.” Though Buffett’s Berkshire Hathaway has seldom bought a public issue, one need not avoid them altogether especially when investing in a high-growth economy such as India. However, one needs to be careful. Let us understand a few factors which will help you make an effective decision when investing in IPOs: 

Avoiding bad apples

In good times even poor quality businesses demand sky high valuations. Investors need to figure out two things: the true worth of a business and if there is money to be made at the IPO price. Investing in a poor quality business is calling for an imminent disaster. It is observed that poor quality companies cash in on market sentiment and post listing gains. They may also trade above their IPO price for some time. But their share price fall drastically as fundamentals catch up. Individual investors rarely get to book losses on time in such companies. Hence, permanent loss of capital needs to be avoided. Hence, investors must avoid such bad apples.

Selecting right bets

In a rising market, valuations appear stretched as markets tend to discount the future. But growth in the near future cannot be ignored. Estimating the future growth and profitability right can help investors race ahead of others. If a price is right in the context of future earnings, then such IPOs can be rewarding for investors. Especially IPOs of companies in sunrise industries, run by able managements and backed by savvy investors can be multi-baggers in due course. Like any other business – you need a solid reason to invest in an IPO. 

Prices adjustment

When a company goes public, there is a fixed set of information available. However, after listing, such a company keeps sharing information periodically. Investors must align their expectations accordingly. If a company does not live up to market’s expectations, then it makes sense to exit such shares. However, there are situations when the share price of a company becomes too volatile. Many times expectations and IPO price are too high to subscribe at the time of IPO. As a company takes some time to deliver on expected growth, impatient investors sell out. The stock price of such companies becomes attractive. Investors who are aware of this changing situation must buy shares of such companies and benefit from any appreciation. Many times it takes months for prices to turn attractive. Only savvy investors understand the meaning and value of being “patient” with companies which have long-term potential.

This three-pronged strategy of IPO investing can be executed better if you place your money in the hands of a dedicated team of professionals. Edelweiss Recently Listed IPO Fund does just that. It helps run a portfolio that contains the best ideas in a hundred recently-listed IPOs. A robust risk management framework contains the downside in this thematic offering. Investors looking to take dedicated exposure to good quality IPO with a medium-to-long-term view can consider investing in this scheme.

(Niranjan Avasthi is the Head – Product, Marketing & Digital business at Edelweiss Asset Management Limited (EAML). Views expressed are his own. Please consult your financial advisor before investing)

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