Daily Insight: Approach IPO investing with caution

Dear Value Research Online Member,

IPO investing is no more a lottery; make sure you see value when investing in them

Coal India changes nothing

Do not draw the wrong conclusions from the Coal India IPO

The recently listed Coal India scrip has been a far bigger success than anyone had envisaged. However, it is important that investors do not draw the wrong conclusions from this. Unlike most issues in recent years, Coal India has had a robust subscription from retail investors. Given the state of the markets, it is also very likely that the stock will register good returns when it starts trading.

However, investors should not use Coal India as a guide to whether to invest in other IPOs to follow, whether from the public sector or from the private sector. The basics of IPO investing have not changed because of Coal India. Whether you make money from a particular IPO or not remains a toss-up that depends on how the general market outlook will be and how generous the promoters are.

To take a less charitable view, it depends on how scared the promoters and the investment bankers are of the issue bombing. For investors, the best combination is that of promoters and investment bankers who are afraid that the issue may not do well along with a robust market at the time of the stock listing. This will ensure a reasonable price coupled with a strong opening. In Coal India's case, this is exactly what has happened. The issue was probably priced reasonably because there was some nervousness about its massive size.

Going forward, this may not be the case. If there's an 'IPO season' up ahead, then investment-worthy issues will have to be selected carefully. The success of the Coal India IPO will doubtlessly encourage other issues to be priced to the hilt. Anyhow, none of this changes the basics of IPO investing, as it applies to individual investors. By and large, it doesn't make sense for individual investors to invest in IPOs. In India, we have this idea that IPOs are somehow especially suited for retail investors. This is an outdated concept that actually makes little sense, as I've written earlier.

There is nothing about IPOs that makes them especially suited for the casual retail investor. If anything, compared to listed stocks, IPOs are actually less suitable for such investors. The reason is simple. IPOs are lesser-known entities. The balance of power (in the sense of information) lies with the seller. The companies have not been in the public eye at all. Invariably, the promoter has spent the preceding months carefully building up an image to ensure that the investing public has a positive image. Unlike listed stocks, the financials haven't been scrutinised by analysts quarter after quarter for years. And of course, the price is the promoter's gambit, rather than one that has been through the price discovery cauldron of the market.

In the case of the government's offers for sale, this is even truer. In this case, while the promoter may not have been able to organise any elaborate window-dressing of the company, the money is not going to the company and is therefore not making any contribution to the improvement of the company's fortunes.

No matter how much of a sure bet an IPO appears to be, investors must approach it with caution. In the old days, it was possible that an IPO could go up by a huge margin on listing and never again be available at the original issue price. Such lottery tickets simply don't happen any more, least of all in a booming market. Each IPO should be evaluated on its own merit, and then most of them should be rejected.

-- Dhirendra Kumar

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Regards
Value Research Web Team