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The Dangerous Illusion of 30-50% Returns in One Day

Dec 28, 2015

In this issue:
» IPOs with highest listing gains in 2015
» In 2016, the IPO bonanza is set to get even bigger...
» ...and more!
00.00
Ankit Shah, Research analyst

At a grand wedding yesterday, I met some relatives, distant cousins, and acquaintances. After indulging in the sumptuous fare, we sat together for a while. In a cliched style, the women huddled together to discuss family gossip, clothes, jewellery, weight loss, and hair colour. For men, the discussions very quickly veered towards politics and money.

When men talk about money, you never have a discussion that misses the stock markets.

After a solid bull rally last year, 2015 has been a dampener. With only a few days left in before the year's end, the BSE-Sensex is down about 6%. But this was not the highlight of the discussion.

The hot topic turned out to be IPOs (subscription required). After a prolonged drought, 2015 has been a solid comeback year for the IPO markets. Consider these facts:

  • Around 21 companies raised capital worth Rs 136 billion in 2015. This is the highest in five years.
  • About 60% of the IPOs that listed during the year are trading at a significant premium to their issue price.
  • The most recent IPOs - Alkem Laboratories and Dr Lal PathLabs - zoomed up over 30% and 50% respectively on listing day.

A couple of gentlemen at the wedding who had enjoyed some recent listing day gains were jubilant. They asserted that it was a good strategy to make quick gains in IPOs at a time when the overall markets were lacklustre. The others who had missed the IPO bus in 2015 appeared to be making a mental note to not miss out the IPO bonanza in the new year.

I kept thinking about this after I returned home. I was worried about investors who were bitten by the IPO bug and thought it was a simple, no-brainer way to make quick bucks.

If you are one of them, let me draw your attention to some important facts that would help you invest in IPOs safely.

  1. IPOs do more to whet appetite than to satisfy your financial goals

    The prospect of big listing day gains draws many investors to the IPO market. Let me ask you a simple question: How much do the allotted IPO shares stand as a percentage of your total portfolio? In many cases, the number of shares allotted is too marginal to make any difference to your overall portfolio returns. So, while 30-50% returns in one day sounds great, it means little if the returns are on a petty amount. The actual gains in relation to the excitement they generate are immensely disproportionate.

  2. IPO gains can do more harm than good

    Don't get me wrong. I am not against IPOs...or against the idea of quick returns... What scares me is the investing behaviour it creates. A spate of rewarding IPOs can create false illusions about how easily money can be made in the stock markets. If you continue to invest blindly, eventually there will be a rogue IPO like the Reliance Power IPO in 2008 (subscription required) that will give you a huge setback.

  3. Invest in the business, not the prospect of listing gains

    Why should you treat investments in IPOs and the secondary markets any differently? You should look at an IPO the way you would look at any stock. If the business fundamentals and valuations merit an investment, then so be it. But to look at IPOs as a way to make quick gains is a dangerous illusion.

In November 2015, our Co-Head of Research, Tanushree Banerjee, wrote a pertinent piece about our contrarian approach to investing in IPOs. I would highly recommend you read it.

What is your investment approach for IPOs? Are you tempted by the prospect of 30-50% listing day gains? Let us know your comments or share your views in the Equitymaster Club.


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2:30 Chart of the day

As I wrote above, 2015 has been a rewarding year for IPO investors. Today's chart of the day shows the IPOs with highest listing gains in 2015.

IPOs with Highest Listing Gains in 2015

It seems that 2016 is set to witness a much bigger IPO bonanza. Seeing the strong investor demand, a slew of companies have lined up their IPOs in 2016.

According to Prime Database (as reported by DNA), 21 companies have already secured a go-ahead from the Securities and Exchange Board of India (SEBI) for share sales worth Rs 88 billion.

Here are some of the major IPOs slated to hit the markets in 2016 - Rashtriya Ispat Nigam (Rs 1.5 billion), AGS Transact Technologies (Rs 13.5 billion), Dilip Buildcon (Rs 7.5 billion), Nuziveedu Seeds (Rs 7 billion), Paranjape Schemes (Rs 6 billion), Matrix Cellular (Rs 5 billion), Matrimony.com (Rs 4.5 billion), and Catholic Syrian Bank (Rs 4 billion).

It is said that 11 more companies are awaiting SEBI go-ahead to raise funds worth Rs 55 billion from IPOs. Some of the major names include - RBL Bank (Rs 15 billion), Mahanagar Gas (Rs 12 billion), Equitas Holdings (Rs 7.5 billion), GR Infra Projects (Rs 5 billion), and VLCC Health Care (Rs 4 billion).

But there could be much more action in the IPO markets as many companies are readying their IPO plans. The overall IPO pipeline for 2016 is estimated at Rs 500 billion.

We again reiterate that investors should invest in IPOs based on the merits of the business and the attractiveness of valuations.

Always remember these lines from the investing legend Warren Buffett:

'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 (company insiders) to a less-knowledgeable buyer (investors).'

4:00

The Indian stock markets are trading on a firm note since the start of the trading session. At the time of writing, the BSE-Sensex was trading higher by about 163 points (+0.63%), while the NSE-Nifty is trading higher by about 50 points (+0.63). Most sectoral indices are trading on a positive note with healthcare, auto and banking stocks leading the gains. However, telecom and metal indices were trading in the red. The S&P BSE Midcap and S&P BSE Smallcap indices are also trading higher by about 0.22% and 0.52% respectively.

4:30 Today's Investing mantra

"Both our operating and investment experience cause us to conclude that 'turnarounds' seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Ankit Shah (Research Analyst).

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1 Responses to "The Dangerous Illusion of 30-50% Returns in One Day"

Harinathan.K

Dec 28, 2015

One of my friends applied for the recent Coffee Day IPO,at its offer price and at the minimum lot of Rs.15,000. Got the allotment but lost about 25% upon listing and sold of a major part at this loss.

But, due to better wisdom, bought back same at Rs.255 and has recovered about 20% as on date.

I agree with your advice, on ultimate objective of owning an IPO Share on long term basis, rather than suffering losses within 15 days of application.

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