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Have these stocks yielded 'Imaginary Profits Only' ?

Mar 27, 2015

In this issue:
» Returns delivered by the most popular IPOs of the decade
» Optimism in Indian markets taking a beating?
» Indian hotel chains look to restructure
» ...and more!

00:00
A subscriber wrote in to us with a grouse he had about an IPO note we issued recently -

"I have avoided the IPO. But it has been oversubscribed by 35 times by QIB & NII. Did I miss a very good chance for listing gain?"

Now, that's a very good question, and one that we get asked quite often in one way or the other.

And with what is now beginning to look like the onset of the IPO season, we're sure to get asked again.

Our subscribers are often very anxious to know our views on IPOs. Not very surprising, considering that investors' interest levels in new IPOs always run quite high.

In a recent article that appeared in The Mint, says the author "For retail investors, IPOs are projected almost like mystical beings, which appear at special times and make investing worthwhile. Returns for IPOs are always expected to be superlative with the ability to surpass returns from other listed shares."

Quite an accurate description we would say. Sadly, this is one of those cases where the reality is far far away from this general perception that people have. The difference in fact is one of night and day. Barring a few rare exceptions, IPOs are a dud investment. And IPO investing, a highly misplaced endeavor.

And what makes this so is none other than the prices at which shares in most IPOs are sold. And all the marketing machinery that goes into creating a buzz around each IPO to ensure that the shares get sold at these high prices.

Think about this - To raise a given sum of money for the company, the higher the price at which the shares are sold at, the lesser the amount of ownership that the promoters of the company have to part with. Is it any surprise that the IPO season comes only when the stock market is rising and stock prices are high?

Sadly, most investors are given to believe that the trick lies in catching those IPOs that are the most popular, because those are the ones that will have the highest listing gains. And listing gains is what it all comes down to...

We at Equitymaster on the other hand, ever cautious of risks to capital before we even begin to get greedy about returns, make our decision on the basis of the fundamental factors of the investment rather than on a prediction of how popular the IPO is likely to be with other investors. Things like the amount of over-subscription and the likely quantum of listing gains depend not just on the fundamentals of the issue, but also on various non-fundamental factors such as the excitement surrounding the issue, the level of optimism in the general market, the amount of marketing put in behind a given issue etc.

We do not believe that such factors and their effects can be analyzed or predicted with any degree of reliability whatsoever. Thus you will find that such factors never ever feature in our analysis of an IPO.

Is it any surprise then that it is the very rarest of rare IPOs that end up getting our stamp of approval?

Do remember that 2015 is expected to see a deluge of IPOs and you need to make sure that you do not buy into any 'imaginary profit' stories.

What do you think about IPOs and IPO investing? Is that where all the money lies? Let us know your comments or share your views in the Equitymaster Club.

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02:30
  Chart of the day
Coinciding with the fact that the very rarest of rare IPOs get our stamp of approval is the very dismal track record of returns that IPOs have delivered to unsuspecting investors. In fact, it almost seems like the popularity of an issue at the time of the IPO is inversely proportional to the wealth it creates!

As per a report in the Livemint, if you look at the domestic IPOs in the past 10 years, of the top 10 oversubscribed issues, only three have given compounded annual returns of more than 10% till date. Today's chart of the day illustrates this most brutal of facts about the world of IPO investing. As you will also see, the IPO that had investors falling the most head-over-heels over the last 10 years, is also the IPO that has destroyed the most shareholder wealth!

Some IPOs that saw the highest over-subscription since 2003

03:05
It is not just the primary markets that investors need to be wary about. The optimism about Indian stocks in general has taken a beating over past few weeks. And this can be attributed to not just the muted earnings performance but several macroeconomic triggers as well. First of all, the overvalued currency is having a bearing on the stretched equity valuations. And this means that the FIIs have multiple reasons to book profits in Indian stocks. Even if they choose to remain patient on the earnings growth, the stronger currency may prompt many to book some profits to lock in the currency gains. Besides these, the fundamental factors that raised optimism about Indian stocks in late 2014 are also fading away. India was seen as among the biggest beneficiary of the sharp fall in crude prices. Not just in terms of impact on current account deficit, but the benign commodity price was supposed to boost corporate earnings too, albeit temporarily. Now, the tide is starting to reverse, the fear of sudden spike in oil prices and therefore inflation, is real. Brent crude prices are already almost 22% above the January lows of US$ 45 a barrel. And the geo political tensions in Saudi - Yemen territories are fraying nerves. Therefore what we want to remind you, dear reader, is that it is indeed a good time to take a hard look at your portfolio. And even though you may be a long term investor, there may be no harm in booking profits only in the stocks where valuations have far outstripped the fundamentals!

03:45
If you need an example of a case where corporates have gone overboard in their hiring and expansion plans at the cost of shareholder wealth, it may be a good idea to look at listed hotel chains. It is no secret that even the biggest hospitality and hotel companies in India have hardly managed to add to investor wealth over the past few years. One can certainly blame poor economic growth and low tourist influx for the same. However, as the managements of these entities have figured out, ill conceived expansion plans and bloated balance sheets have been their biggest pitfall. These companies have therefore been in a restructuring phase over the past few months to reduce leverage and overheads. With the addition of nearly one lakh rooms and 430 hotels in 2014, the occupancy rates are likely to remain muted. And this could impact the average room rates too. So while these entities will have to overcome the pressures of low occupancy and falling ARPU, some efficient cost management could save the day. For investors like you, while cyclicality of sectors like hotel industry will remain important, what you need to watch out for is whether a seasoned player is available at a discount due to temporary problems.

04:45
The Indian stock markets traded on a volatile note today dipping into the negative during the afternoon session. However, they managed to close the day on a flat note. The BSE-Sensex ended the day with negligible gains. Gains were largely seen in capital goods and banking stocks.

04:55
 Today's investing mantra
"It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller to a less-knowledgeable buyer." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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2 Responses to "Have these stocks yielded 'Imaginary Profits Only' ?"

Ravi shah

Mar 28, 2015

I wd suggest don't get lured by critisism of people by orecommending bad companiens bcz capital protection is more important than short term gambling of listings.You must never betray your subscribers' faith over the pressures of biased recommendations.Be always investors'best friend without being swayed by public pressure.

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Raviraj

Mar 27, 2015

You are correct in saying this.
I've been a member of EM for more than 9 years and based on your suggestion I've never applied for any IPO's or NFO's as the retail investors are always taken for a ride in IPO's and during the listing the shares are offloaded by big players and the stock price goes down than the allotted price. Its always better to buy the stocks in the secondary market as we'll be able to know the actual performance and the price the market is willing to pay.

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