Is this the right time to invest in IPOs? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is this the right time to invest in IPOs? 

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In this issue:
» Will 2014 see a comeback of IPOs?
» Global macro risks will play a big role
» Food inflation is a big risk for India
» Reviving growth will be a huge task for Mr Modi
» ...and more!

We have all seen how the Modi euphoria has fuelled the Indian stock markets in recent times. Indeed, one of the reasons why the Indian economy has slowed down is because of lack of any meaningful policy making by the previous government. And now that Mr Modi has assumed office as the Prime Minister of the country, there are considerable hopes that he will deliver on his development agenda.

This has sparked off a rally in the Indian indices. So much so that brokerages, TV houses and the so called experts have started spelling out Sensex targets. Infact, we recently highlighted in one of our editions of the 5 Minute Wrapup, how the private banking arm of a large bank was of the view that the Sensex will touch 40,800 levels three years down the line!

Now this euphoria has not just been limited to the secondary markets. Infact, it has spilled over to the IPO market as well. A host of companies have geared up to capitalise on this buoyancy and come out with their public issues. Not just that, there seem to be makings of a revival in qualified institutional placements (QIPs) too. Most of these companies are hoping that the money raised would enable them to retire debt and take advantage of the faster economic growth that many are anticipating. Just to give a flavour of the kind of enthusiasm one is seeing in the primary markets, an article in the Economic Times has stated that India's biggest coffee chain is looking to come out with an IPO next year. And this company could possibly seek a valuation of US$ 1 bn!

Now, investors during such times need to be very cautious. When there is so much hype and hoopla in the IPO market, most of these primary issues tend to get mis-priced. Most of the companies coming out with IPOs want to capitalise on this euphoria and command premium valuations. This is even when earnings growth and financials do no support such high prices.

That is why we believe that investors should not get carried away by all this noise. We would like to point out that the discipline that one needs to follow when investing in listed stocks also applies to IPOs. In others words, the investing process for both the secondary and the primary market remains the same. That means investors need to judge the moat of the business, the sustainability of profits and management quality of the businesses offered through the IPO route. Just like they would do for companies whose stocks are already listed.

Thus, if investors come to the conclusion that a particular IPO is too highly priced, there is no harm in giving it a miss. Infact, it would make sense to invest in stocks that are already listed that have a proven track record and are available at better prices.

Do you think that IPOs in general tend to be over priced? Do you intend to invest in any of the IPOs likely to come out in 2014? Let us know in the Equitymaster Club or share your comments below.

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01:36  Chart of the day
Just to give a flavour of how activity in the IPO market shoots up when there is a bull run, the chart below depicts the amounts raised by IPOs 2007 onwards. As you can see, the years 2007 and 2010 were very bullish years for the stock markets and consequently the amounts raised from IPOs also shot up. Since 2010, there has been a lull in the IPO market. Indeed, as per SEBI, in the last three years a lot of companies with plans to raise around Rs 600 bn had dropped the idea due to poor market sentiments. The scenario is likely to change now. As bullish sentiments prevail, we expect IPOs to make a comeback in a big way. And while the amount that has been raised so far in 2014 seems quite miniscule, we will not be surprised if this figure shoots up in the coming months.

That is why we would once again like to reiterate that investors need to be careful when investing in IPOs. For instance, in 2007, when buoyant sentiments ruled, investors made a beeline for IPOs like DLF and Reliance Power, only leaving them later with losses. In this regard, we would like to quote a very interesting statement from investing genius Warren Buffett here: "Only when the tide goes out do you discover who's been swimming naked." So make sure you don't get carried away with euphoria. Exercise due diligence and invest only in players that have strong fundamentals and are available at attractive valuations.

Will come IPOs make a big comeback in 2014?

Valuations are unlikely to be the only risk to Indian stocks, we reckon. In fact global macroeconomic risks will have a much bigger role! There is enough evidence that the West tends to be hypocritical when it comes to economic policies in the Asian region. The depreciation of the Chinese Yuan in particular has always drawn critical comments from regulators in the West. That China has chosen to artificially keep its currency lower is no secret. In fact, the US and Europe have always confronted Japan and China on their efforts to weaken their respective currencies. Yet, little is done when European officials purposely talk the euro lower. In recent months, much of the discussion about the ECB's policy options relate to combating the strength of the euro.

We are hardly surprised that RBI governor Dr Raghuram Rajan is plotting to beat the Western central bankers in their own game. In fact, he has suggested that he may intervene in currency markets to keep the exchange rate down and build huge reserves. Of course this is in response to the US Fed's faulty cheap money policies which are threatening to create yet another financial crisis. However, Dr Rajan's plan, which he calls Quantitative External Easing or QEE seems geared enough to help India conform currency as well as liquidity crises. But investors have to be mindful of the fact that currency risks are here to stay and therefore holding some portion of one's portfolio in gold is a must!

One of the biggest risks to the India's growth story is food inflation and this has been a major issue for a while now. While the price rise seem to be coming under control over the past few months, the fact of the matter is that they are still high. As of April 2014, food inflation stood at 9.66%. A month earlier it was at 9.1%; nevertheless it has cooled off quite a bit when compared to the November 2013's figure of 14.72%. Controlling food inflation is high on the agenda of the new government. And towards that, all state governments have been asked not to hoard food items in anticipation of a poor monsoon.

As reported by the Business Standard, other efforts include revamping the Agriculture Price Marketing Committee Act, evolving a single national agriculture market and enlarging the scope of priority sector lending. It may be noted that food inflation has the highest weightage (about 50%) when it comes to calculating the headline inflation figure. As such it does indicate the importance of containing the same, which if not dealt with could be a major risk. Having only fallen to single digits in January 2014 - after a long time - this has been a real cause of concern. As reported by the RBI, the rising rural wages have been a key factor for rising production costs as manpower availability has been a challenge. Increasing farm production (through mechanization), curbing supply bottlenecks as well as containing rising wages of farmers should be the key areas to focus on, we believe.

Indeed, while all hopes are pinned on the Modi government turning around the fortunes of the Indian economy, there is no doubt that the new government has some challenging times ahead of it. Take GDP growth for instance. For FY14, this came in at a poor 4.7%. While it was a tad higher than the 4.5% that was recorded in FY13, this is hardly a cause for comfort. Indeed, this growth pales in comparison to the 8.6% and 8.9% growth rates recorded in FY10 and FY11 respectively.

That is why investors need to put things in perspective. The stock markets may be running ahead at a brisk pace, but the Indian economy still has a lot of catching up to do. As mentioned earlier besides poor growth, the biggest challenge is fighting inflation. The good thing is that economic revival is high on the government's agenda. And while we will give the new government the benefit of doubt when it comes to reforms and policy making, we are of the view that it could be some time before these are effectively implemented. That is why it is important for investors to understand the underlying cause of the current rally in the markets and then compare it with the roadmap that the government reveals in the coming months.

While stock markets across the world largely remained steady for the week gone by, the Eurozone outshined this time around. The major European indices closed on a fairly firm note this week. The likelihood of the European Central Bank (ECB) delivering monetary stimulus next week boosted the momentum in the European indices. All eyes are now on the ECB policy meeting! The US indices, on the other hand, closed almost flat but the expectations of a sharp economic rebound are quite rife.

Among Asian indices, Japan and China stood firm. Back home, the Indian markets lost momentum towards the end of the week as the GDP growth for FY14 came in quite low at 4.7%. Investors are also remaining cautious ahead of the RBI Monetary Policy review scheduled next week, i.e., 3rd June 2014.

Performance during the week ended May 30th, 2014
Data Source: Yahoo Finance, Kitco

04:56  Weekend investing mantra
"You are neither right nor wrong because the crowd disagrees with you. You are right (or wrong) because your data and reasoning are right (or wrong)." - Benjamin Graham
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1 Responses to "Is this the right time to invest in IPOs?"

y n vijaykumar

Sep 22, 2014

yes in my opinion and there will be good boom expected in the market within 2 months.

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