IPOs: Watch out!

The current fiscal has proved to be a dream run for investors with the secondary markets beating all estimates by the so-called experts, who revised targets below 5,000 after the change in government in May. Not only has the secondary market outperformed major global indices, but the primary market also witnessed robust activity with over Rs 103 bn flowing into the system through the six IPOs listed so far.The primary markets boom could largely be attributed to the liquidity factors, general market buoyancy along with fundamentally strong companies coming in at the right time. This article takes a look at the performance of some of the issues from the listing period till date.

As is evident from the table, Bharati Shipyard is a major gainer. The company's stock was oversubscribed by over 78 times in the recent IPO and listed at a premium of 97% to the issue price of Rs 66 per share. The company is engaged in design and construction of sea-going, coastal, harbour, inland crafts and vessels. At Rs 66, the stock was issued at a P/E multiple of 2.3 times its annualized 1QFY05 earnings. At Rs 120, the stock is trading at a price to earnings multiple of 4.2 times.

While this is history, there are some aspects, which a retail investor has to bear in mind before subscribing to IPOs that are lined up in 2005.

1. Besides some of the fundamentally strong companies that are planning to tap the market, there will also be a bunch of 'also-runs'. This is typical of a bull market (commodity IPOs in the early part of 1990s, the NBFC IPO boom in the mid-1990s and the tech IPO boom in the late 1990s, to name a few). Looking back, as per a SEBI study, half of it has already vanished with investor's money.

2. When a company is tapping the primary market to raise capital, typically, the objective is to get a 'fair price'. Looking it from the issuer's perspective, it benefits if the price is high i.e. 'better valuation'. This is perhaps one of the reasons why IPOs, in totality, have not been that rewarding on a point-to-point basis as it has been made out to be. Of course, there are exceptions.

3. Instead of investing in IPOs to capitalize on the 'higher listing price' as compared to the offer price, investors would be well off if the approach is 'buying the company as opposed to buying the stock'. In a bull market, high oversubscription rates are not something that investors should bank on. It can be misleading at times.

4. The long-term valuations of a company is not only determined by earnings growth, but also is influenced by the management's track record, ability to tide over economic cycles and consistently delivering results as opposed to performing in spurts. In this context, investing in IPOs is risky and the managements have not been in the investor's radar.

Given this backdrop, before subscribing in 2005 and beyond, it is important to consider the risk factors before investing your hard-earned money.