|»5 Minute Wrap Up by Equitymaster|
On This Day - 20 MAY 2013
Should you subscribe to IPOs with 'safety net'?
In this issue:
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.
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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.
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.
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