CHARGE OF THE IPO BRIGADE

The market buoyancy is taking IPO valuations to newer heights. But in the rush for listing gains, one must not lose sight of the risks that lurk alongside. Ramkrishna Kashelkar lends you a hand so that you can stay away from the quicksands

IT is still a month to go for the great Indian festive season to begin, but celebrations have already started on Dalal Street. The bulls have lodged a fresh, and this time even mightier, charge against bears. Stocks and stock indices have bounced back to the levels seen two and a half years ago.
While the secondary equity market is witnessing all this and more, the primary market encompassing initial public offers (IPOs) is not far behind. The IPO segment of the equity market has caught up on the euphoria with a dozen issues hitting the market in a span of just two weeks. With more such IPOs likely to come up in coming weeks, it is necessary for retail investors to be more diligent while investing in an IPO. This week, ET Intelligence Group brings you the finer points of IPO investing that you must keep in mind while wading through a spate of issues.
Since the beginning of 2010 till the third week of September, India Inc has raised over 15,000 crore through the IPO route. Onefifth of this amount, or over 3,100 crore, has come in the past two weeks alone. Most of these IPOs were successful in raising funds in staggering multiples of the required sum. For instance, the Kotabased tutorial service provider Career Point Infosystems intended to raise 115 crore from the primary market. By the time its issue closed, it had attracted 47 times more money.
It seems the 'listing gains' bug - just as in the second half of 2007 - has bitten investors yet again. And, why not? The recently listed companies such as Technofab Engineering, Bajaj Corp, SKS Microfinance and Gujarat Pipavav have all given a double-digit return on the listing day itself. And if one had invested in the IPO of Prakash Steelage and sold out on the day it got listed, the gains would have been a whopping 71%. Even in the last boom phase, five out of every six IPOs resulted in listing gains; in nearly 40% cases, gains being more than 50% of the offer price.
Huge unmet demand for the IPO - reflected in the over-subscription numbers - is the primary reason why stocks tend to jump to unrealistically high levels on their stock market debut. Moreover, the book running lead manager is legally allowed to support the stock price of a newly-listed company for a specified period of time.
As valuations of IPOs touch new highs, the risk of ending up with an unproductive over-valued investment increases for investors who invest not to get listing gains but to park their money over a longer term.
A look at the past phase of market boom explains the matter. Even though three long years have passed and the Sensex is once again beyond 20,000, a whopping two-thirds of the IPOs from the second half of 2007 are still trading below their issue price.
IPO is a process where promoters sell a part ownership of their company in which they had so long invested. In a buoyant market, the price of equity tends to be much higher than what could be justified. Investors mustn't neglect this aspect in their rush for 'listing gains'. For example, at the peak of the previous boom, Reliance Power had sold its shares at 430 apiece to retail investors. Soon, the market crashed and the company offered three bonus shares for every five existing shares, thereby reducing the IPO price by 40%. Today, the scrip still trades 40-50% below this bonusadjusted IPO price.
It may come as a surprise to many, but a number of experts consider IPO investing risky. In fact, none other than Benjamin Graham, the father of 'value investing', has recommended in his most decorated work 'The Intelligent Investor', to stay away from all initial public offerings. "IPOs are only sold when Mr Market is in his most optimistic mood, and therefore, by definition are almost always a bad buy, with the promoters cashing in on the enthusiasm of investors," he had remarked.

GUIDELINES OF IPO INVESTING:
Of course, not all IPOs are bad. For example, those who invested in IPOs of Jyothy Laboratories, eClerx or V-Guard Industries have already more than doubled their capital in spite of the fact that these IPOs hit the market during the peak of 2007-08. But for every winner, there are dozens of losers. It is necessary, therefore, to separate these winners from the mob. Investors can check the following guidelines as to how to go about IPO investing

DO YOUR OWN RESEARCH
The IPO company's financial and other information, along with risk factors, industry scenario, issue details and objects of fundraising are given in the prospectus. An investor should go through these details to figure out how things stand on the ground.

CHECK PROMOTER BACKGROUND
Reputation, qualifications and success of any previous ventures of the promoters, along with pending litigations, post-issue promoter holding, other group companies, related party transactions and conflict of interest should be checked.

COMPANY'S FUNDAMENTALS
Company's financial history, its capacity to generate profits and cash, use of funds, indebtedness and working capital management are the key points to study.

PAY ATTENTION TO VALUATION
Often, the prospectus mentions valuations. However, it is calculated on the existing equity base without considering the IPO dilution. Since investors get shares only after the equity dilution, they need to calculate the valuation multiples on the post-issue equity. Priceto-earnings (P/E), price-to-book-value (P/BV), dividend yield are some of the criteria that can be used. A comparison with the peers can identify the over-valued IPOs.

YOUNG COMPANIES IN HOT SECTORS
New companies mushroom in a sunrise industry. Many a time, such companies may lack in vision or may not be able to scale up activities in future. Green energy, water management, infrastructure, power are some of these hot sectors at present.

INVEST WHEN MARKETS ARE COLD
When the markets are in euphoric mood, the valuations tend to move to unsustainable levels. However, IPOs coming out when markets are dull hold better promise of sound valuations. Research is, however, essential.

TAKE EXPERT ADVICE
When you can't do the homework yourself, take an expert's opinion. Make sure it is an independent expert - your broker is more likely to suggest investing at the slightest justification. It is better to compare opinions of more than one expert. Websites dedicated to investors community including www.etintelligence.com can prove to be a good source of information.
If the art of investing is difficult, IPO investing is even more so. For investors, it remains a high-risk, high-reward strategy. As Mr Graham put it, "No matter how many other people want to buy a stock, you should buy only if the stock is a cheap way to own a desirable business". Don't buy a stock only because it's an IPO - buy it because it's a good investment.