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How to Profit from Sensex' Steepest Pre-Budget Correction in 7 Years

Feb 25, 2016

In this issue:
» IPO is a dangerous game
» Market round up
» ....and more!

0.00 Chart of the day

Richa Agarwal, Research analyst

The Union Budget announcement is due on Monday. The government is under huge pressure to deliver. Touted as the 'Do or Die Budget', the Finance Minister is expected to come up with the roadway to achieve what the government promised since May 2014.

Last year was loaded with 'great expectations'. And it certainly took long to come to terms with economic reality. While expectations are realistic now, it hasn't made the Mr Jaitley's job any easier.

The global economic scenario offers little to support growth. Domestic demand is weak. The growth this year to a large extent will depend on how monsoons play out. As banks are ridden with bad debts, monetary policy too won't help beyond a point. Divestment in the current market is unlikely to achieve the desired objective. A lot of onus to support growth rests on fiscal spending then.

So will the fiscal deficit target for FY17 be relaxed to make way for more spending and investment? Will the government take a tough stand on reforms and their execution to mobilise growth. The upcoming budget will answer some of these questions.

No wonder the budget is the most awaited event for the market. Most investors are waiting on the sidelines for the big announcement. Budget blues have added to the weak sentiments.

As today's chart suggests, the sharp correction this February is noteworthy. The year-on-year correction in the Sensex this Budget month has been the steepest in the last seven years. And while a lot of investors are getting nervous about this correction, we would like to point out the long-term silver lining for investors.

Sensex Faces Steepest pre-budget Correction in 7 Years

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2.50

So the secondary market has woken up to economic reality. But what about the primary market (IPOs)?

Are investors equally cautious when it comes to IPOs?

Here is an interesting conversation my colleague Sarvajeet had with this friend On IPOs. It offers interesting insights on investors' behavior when it comes to IPOs. Over to Sarvajeet...

Last weekend, I met my old friend from school days. Excited and happy. Meeting after a long time. We discussed everything. College, job, friends, life and future...In our discussion, my friend spoke about investments and particularly about IPO (Initial Public Offering).

Conversation went like this:

My Friend: You know, a lot of IPOs are coming these days. I am excited.

Me: Why?

My Friend: Why? Look at listing gains. Stock up 20%. Stock up 50%. Wow. This is how you get rich. Isn't it?

Me: So you are a rich person now...

My Friend: No. not really.

Me: Why? You aim for listing gain right?

My Friend: Yes. But it is not easy. You also lose money as well. Some companies create hype and on listing day... they collapse like a pack of cards...

Coming back to reality...

This is how it happens... in real life... People aim for listing gains and miss the big picture. And we all know the results.

This forced me to think about the investments and particularly an IPO (subscription required) and how often we pay too much.

Consider an IPO. The aim of the company is to get the maximum valuation for its share listing. Why? The answer is simple. Private equity (PE) investors, Venture capital (VC) investors, or a promoter himself wants to sell a part of his holding. Why would he sell at a discount? The Promoters will seek a premium valuation. The investment bankers will certainly make sure that company gets a premium valuation.

Surely, a company will come out with a good story. They will say, the company is growing at x%. There is a huge market potential. Our Market share is increasing.... and so on. In such case, investors (which includes Institutional investors, FIIs, and retail investors) would want to participate in company's growth story. This will come at hefty valuations.

In an IPO meet, I asked one question to the management about the steep valuation and rationale behind such valuation. Here comes the reply as expected. 'Look, this is a growth story. We have been growing at xx% previously. We are the only listed company in this segment. You can consider this business as defensive...'

I also observed another weird thing in the IPO meet. Analysts present in the meeting did not bother to ask the question about valuation at all. They were focused on other things. Key revenue drivers. Growth opportunities. Operating margins and so on. Make no mistake; all these questions are important but it is equally important not to ignore the valuations at which company plans to sell its stake.

I was going through a business newspaper the other day and read how companies are planning to postpone their IPO plans amid stock market volatility. Why would they do that? Think about it. Are they sensing the market mood? It seems like a big yes.

Now under such circumstances, I looked at what an investment legend had to say. Warren Buffett said that IPOs are almost always bad investments. There is so much hype involved that IPOs won't be the most-attractive value. Investors should be looking for good businesses to buy and trying to determine how those companies will fare in next 5 to 10 years.

I told my friend 'IPO is a dangerous game. The odds are stacked against you. Be very careful. Understand the business, don't pay too much. Look at IPO from long-term perspective.'

In the primary market, the company fixes the price. Once the share lists on the exchange, it is the market which determines the price.

So when the odds are in your favour, play your game. Until then wait, wait, and wait...

How do you look at IPOs? You aim for listing gain or look at from a long term perspective? Let us know your comments or share your views in the Equitymaster Club.

4.45

At the time of writing, the Indian Stock market continued to be volatile with negative bias ahead of expiry of February derivative contracts. The BSE-Sensex and NSE Nifty trading lower by about 139 points and 55 points respectively. The BSE Mid cap and BSE Small cap indices were also trading in the red. Amongst sectoral indices, Banking, Auto and Capital Goods were hit particularly hard.

4.50 Today's Investing mantra

"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas." - Paul Samuelson

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Sarvajeet Bodas (Research Analyst).

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Equitymaster requests your view! Post a comment on "How to Profit from Sensex' Steepest Pre-Budget Correction in 7 Years". Click here!

1 Responses to "How to Profit from Sensex' Steepest Pre-Budget Correction in 7 Years"

Sandeep

Feb 28, 2016

pLS GIVE ME THE STOCKS NAME best 4 as per your mail for a trial .
it wud satsify me on your credentials .

tks

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Equitymaster requests your view! Post a comment on "How to Profit from Sensex' Steepest Pre-Budget Correction in 7 Years". Click here!
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