Stock markets: How to ride the IPO wave; here’s all you need to know

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New Delhi | Updated: March 24, 2017 2:17 PM

THE stellar debut of Avenue Supermarts (ASL), the operator of supermarket retail chain D-Mart, on the bourses is drawing investor attention.

Analysts expect demand for the stock to continue as there is not much free float given the promoters had diluted only 10% stake to raise Rs 1,870 crore. (Reuters)

THE stellar debut of Avenue Supermarts (ASL), the operator of supermarket retail chain D-Mart, on the bourses is drawing investor attention. As one of the best listing-day performances, the stock listed at R604.75, a gain of 102% over the issue price of R299 on the BSE. The record listing-day gains follow a whopping response to the company’s initial public offering (IPO), which was subscribed 105 times. The retail investor portion saw 7.51 times more demand than the shares on offer.

Analysts expect demand for the stock to continue as there is not much free float given the promoters had diluted only 10% stake to raise R1,870 crore. They are advising investors to book profits as listing gains have been much better than expected. Fresh investors should ideally wait till D-Mart reports earnings for two quarters before deciding to buy the stock.

Past performance of IPOs

Last year, the IPOs of Quess Corp and Thyrocare Technologies gained 57% and over 48%, respectively, on listing-day. Given the surge in IPOs and record over-subscription by institutional investors, investors need to be a bit cautious. Typically, IPOs are timed to coincide with the company’s top of the cycle growth, margins, earnings and valuations.

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A recent study by Spark Capital shows that of the 370 IPOs with offer size of over R5 crore since 2002, around 70% of such IPOs have underperformed the Nifty and over half are trading below their listing price. The report says that for 60% of the IPOs since 2008, the average stock price performance since the listing-day has been negative in one- and three-year horizons after listing, irrespective of the listing gains or losses.

Even for those few IPOs that have given positive returns since 2008, nearly two-thirds have delivered higher returns in the fourth year as compared to the first three years after listing, implying the IPO price and listing-day gains seem to have fully captured the medium term upside.

“Exiting on listing-day and taking a fresh look on the stock after observing the ensuing three-year company performance seems to be a more sensible investment strategy,” the report says.

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Ways to invest in IPOs

Retail investors must look at a company’s fundamentals before investing in an IPO. You must read the red herring prospectus of the company, which gives details of the revenue and earnings for the past few years. Check if the company is profitable, has cash flow and the risks are properly underlined. Check the mandatory IPO grading, done by at least one credit rating agency. A grading of 4 out of 5 is considered good.

Note if the company’s financials are consistent with its peers. If they are better or worse than peers, identify the reason by analysing volume and realisations, capacity utilisations, asset turn- over ratios, etc. Keep in mind that the price one pays for a share in an IPO is always for the company’s future performance. One must look at the past performance to estimate how well the company is going to perform, going forward. If the company’s performance is good, one can expect a higher gain as the stock market rewards capital appreciation.

Analysts say valuations should be looked at in terms of cash flows, earnings, corporate governance, debt-to-equity ratio and returns. Ideally, to generate higher returns from equity, investors must look at both fundamental and technical valuations.

Betting big on IPOs

Read the red herring prospectus (RHP) of the company carefully

Look at valuations in terms of cash flows, earnings, corporate governance, debt-to-equity ratio and returns

Check if the company’s financials are consistent with its peers

Look at both fundamental and technical valuations to generate higher returns from equity

If you miss out on listing-day, wait till the company reports earnings for two quarters before deciding to buy the stock

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