Should you subscribe to IPOs with 'safety net'?

May 20, 2013

In this issue:
» Not the time to be bearish on India
» RBI moots review of all bank licences on 'fit & proper' norms
» Should investment schemes offering high returns be banned?
» Fed's artificial inflation will end badly: Jim Rogers
» and more....

In 2012, the retail investors had turned cautious when it came to picking up stocks in the primary (IPO) market. This is because most of the companies that came out with IPOs in 2012 either ended up offering spectacular returns. Or fell completely flat on the face. It was like playing cards with the deck stacked against you. No one could predict if the IPO would be a success or not. Therefore to such retail investors who were exercising caution, the recent IPO announcement by Just Dial Ltd would come as a breath of fresh air. The reason for this is the offering of a 'safety net' on the investment.

The safety net is a process by which the company will buy back its shares from retail investors at the IPO price, in case the stock falls sharply during the first six months after the listing. The buyback offer will trigger if the volume weighted price of the stock for the previous 60 days post completion of six months is below the allotment price for retail applicants. So in all probability for a retail investor, any issue should look good if it has a safety net provision in it right?

If you have answered yes to the above question, then you are committing one of the biggest follies of investing. The only reason to pick up a company, whether in an IPO or otherwise, is when it has a safety moat. Safety moat is the sustainable competitive advantage that the company has. This is the moat that would protect the business from competition. And if the company is able to use its competitive advantage to widen the moat over time, then it is the perfect business to be in. It is also the presence of this moat that helps the company deliver higher returns to shareholders for a prolonged period. This in turn propels the value of the company's stock as well. So the things to look at while investing in an IPO would be to see if the stock has a safety moat. And if such a company is being offered at attractive valuations, then investors should look at investing in the stock.

The 'safety net' provision in IPO pricing, in all likelihood, will only encourage speculators to invest even in over priced IPOs for listing gains. Investing simply for the sake of a safety net makes no sense in our opinion. Because eventually the stock's value will catch up with its fundamentals. This may happen after the safety net period ends. And if the fundamentals are not too strong, the stock will only burn a hole in the investor's portfolio.

Which do you think is more important when it comes to investing in an IPO - safety net or safety moat? Please share your comments or post them on our Facebook page / Google+ page

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 Chart of the day
The government has been taking all possible steps to curb the import of gold. The Finance Minister even spoke of how gold is not as bright an investment as investors seem to think it is. Nevertheless, despite all the efforts, India's love for gold seems to be still strong. The measures have failed to curb the imports as well as the supply of gold in the country. The love affair with gold that we saw in 2012 has continued into 2013 as well. For the first quarter of the fiscal year 2013 (1QFY13), the net imports of gold stood at 215 tonnes while supply stood at 238 tonnes. Though this is lower than what we saw in the preceding quarter (4QFY12), still it continues to exhibit a positive trend. The yellow metal has seen prices come under pressure in recent times. But still its strengths as a safe haven and hedge against inflation continue to be strong. Therefore investors would do well to allocate at least 5% of their portfolios towards gold. For more information on how to allocate your overall exposure to equities please ensure that you broadly follow our suggested asset allocation.

Source:Financial Express

At Equitymaster we follow a bottom-up approach to investing. That is, our research focuses strongly on individual stocks. Of course, that does not mean we ignore the macroeconomic factors. We do take into consideration industry and economy dynamics in our future forecasts. But we don't see much merit to forecasting trends in interest rates or business cycles. Investing legends such as Warren Buffett and Peter Lynch have also followed a similar approach. They never paid much attention to economic indicators.

Many investors had turned bearish on Indian stocks on account of the slowdown in the economy and a slew of other negative indicators. This view suddenly seems to be shifting the other way. The trigger for this has been the fall in inflation during the month of April 2013. At 4.89%, this was the lowest level since 2009. Many are of the belief that with the inflation rate easing, there would be room for further cuts in interest rates. The lower interest rates would revive investments and demand in the Indian economy. And this, in turn, would result in better corporate earnings.

The logic sounds so tempting you almost want to buy into it. In fact, this one piece of data has sent Indian stock markets rallying. But wait! Is a drop in the inflation rate for just one month a good enough indicator? We don't think so. In our view, one should not give undue importance to such short term economic indicators for long term investment decisions.

The Reserve Bank of India (RBI) is finally showing some teeth. We had earlier written about how we were thoroughly disappointed with the central bank's audit report on the operations of HDFC Bank, Axis Bank and ICICI Bank. Adopting a diplomatic approach, the RBI had cited 'aberrations' in the operating norms of these banks. It had also denied systemic risks in the sector through the money laundering transactions. But it seems that the regulator was yet to reveal its cards. In a fresh update on the audit, the RBI has proposed a review of all banking licenses from the 'fit and proper' angle. It therefore appears that the central bank will now have a sweeping review of not just those who have been accused of money laundering but even otherwise. No doubt the RBI does smell a rat. And as we suspect, it believes that the managements of several more entities need to come under the scanner. Allegations apart, the business of banking is anyways very sensitive and at the core of the economy. Hence, a thorough review of quality of management and business operations is certainly a good move, we believe.

Following a recent scam involving, Kolkata-based Sharada Group, the reputation of the entire investment industry has been tainted. So much so that Members of Parliament (MPs) are pressing for a blanket ban on schemes that offer unrealistically high returns. This scam is an important lesson for all of us. When someone offers high rate of return and that too guaranteed, ask till you are fully satisfied about the possibility. High rate of return is possible only when there is a high degree of uncertainty. Certainty of returns can only offer low rates of return comparable to the return on fixed deposits of banks. Otherwise, an investor who gets lured by high return on investment often puts the return of his investment in great danger. What should one do as an investor? Managing our investments is not just our need, it is also our responsibility. If one understands the role of investments in one's life, the focus automatically gets diverted on the life-time needs of money and all the short-cuts are forgotten.

So what's the latest with Jim Rogers? Well, his latest interview with Newsmax TV has opinions on practically all the hot burning topics of finance currently. And these are pretty much in line with our views on the very same topics. Rogers reaffirmed his position on QEs that this entire experiment is going to end in tears. "There's this gigantic artificial flow of money floating into our economy, and this is going to end badly because it is artificial," he asserted. And he outlined two scenarios on how this could possibly end. Scenario one is where markets will not take it anymore and bonds will go down despite the central banks. And scenario two is when people will dump paper money with price going higher and resulting in more unrest across the world.

He also finds it astonishing that dollar which is a terrible flawed currency itself is up strongly against both the Euro as well as Yen. Lastly, he is not too worried about the gold's recent tumble as he believes the yellow metal is going through its normal correction phase. Something that it did not have even once in the past twelve years. Given the man's track record, one would ignore him at one's own peril.

In the meanwhile after opening the day on a positive note, Indian equity markets continued their journey above the dotted line. At the time of writing, the Sensex was up by about 82 points (0.4%). Barring Korea, the other major Asian markets have closed the day on a high note with Japan and Hong Kong leading the gains in the region.

 Today's investing mantra
"Cash combined with courage in a time of crisis is priceless." - Warren Buffett

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    1 Responses to "Should you subscribe to IPOs with 'safety net'?"

    sunilkumar tejwani

    May 21, 2013

    the current ongoing I P O of Just Dial is overpriced. Safety Net is a sham. My advice: stay away!!

    Equitymaster requests your view! Post a comment on "Should you subscribe to IPOs with 'safety net'?". Click here!