X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
The type of investment you should definitely avoid - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Oct 5, 2009

    The type of investment you should definitely avoid

    The infamous IPOs are back once again. After the IPO fever ended with a huge number of investors burning their fingers in the Reliance Power issue of January 2008, new IPOs almost completely disappeared from the scene. All the hopeful companies waiting in line to come out with their own issues abandoned their plans almost overnight. Afterall, IPOs need a certain kind of optimistic environment to work their magic on people. And believe us, highly skeptical investors is the last thing they want.

    But now they are making a comeback. Even though investors are not as euphoric as the heady days of January 2008, a miraculous rebound in the markets from 8,000 to 17,000 on the Sensex has set the stage for expectations of a further up move. And that's perfectly the kind of environment that companies are always waiting for to come out with their offerings. In the last 4 weeks itself, 20 new companies have filed their draft offer documents with SEBI, surpassing the 15 filings in the rest of the entire year of 2009. We expect that to only increase in the coming days if the stock markets continue be as buoyant as they are right now. And with that, you can also expect a bombardment of ads, brokers and distributors, all trying to pep you up to apply.

    So how should you approach these IPOs? Is applying to IPOs a good way to create wealth?

    Those are important questions. But before we discuss the answers to these questions, here's a quick fact. Warren Buffett, one of the richest people in the world, and who has made all his wealth by investing in companies over the course of half a century, has never ever applied to an IPO. Is that any coincidence? Or do you think that's intentional?

    Yes, that is nothing but intentional. And if you would like to know why he does that, or who taught him to do that, read on...

    It was Buffett’s teacher and mentor Benjamin Graham that was completely against the idea of applying to IPOs. He had many well grounded and solid reasons for the same, and we shall endeavor to enumerate them in this article.

    There are all kinds of IPOs - the good, the bad and the ugly. But even though different IPOs are of different qualities, there are some general realities that Graham suggests one should keep in mind at all times.

    First off, if you need to be cautious while purchasing shares of a company from the secondary market, you need to be twice as cautious and wary while doing so in an IPO. The reason for this is that IPO's have a much higher amount of salesmanship and marketing effort put behind them when compared to shares that are already in the market. In fact, you may be surprised to know that investment bankers make significantly higher commissions to sell a new issue to the public than do brokers when you buy from the market. Thus if brokers have reason to be enthusiastic about having you keep buying and selling in the market, you can imagine just how much more motivation the investment bankers will have to make you apply for an IPO. And so, if new issues indeed have such a special degree of marketing effort behind them, its calls for a special degree of 'marketing resistance' from your side.

    Even more dangerous is the fact that this marketing tends to get progressively more stronger and aggressive as the issuing company gets smaller, riskier and expensively priced. This is all the more because the commissions that investment bankers make on an IPO tend to rise as the issuing company gets smaller and more riskier.

    Secondly, most IPOs are always sold under favourable market conditions. But the question you need to ask is - favourable to whom? For it is only logical that if it is more favourable to the seller to sell during those times, it has to be that much less favourable for the buyer to buy during those times.

    Many a times you will find that the companies coming out with IPOs have had a fabulous performance in the last 2 - 3 years. But if you go back earlier than that, this good performance might not have been the same. Even though one could make the assumption that the recent performance will continue without any serious setback, according to Graham this would be an unsound approach to investment, and one likely to prove costly.

    Further, there are many more IPOs in which the company has yet to make a single rupee in profits, but lays down elaborate and convincing plans about how and when it intends to become profitable. So what about them? Says Graham, "The more dependent the valuation becomes on anticipations of the future - and the less it is tied to a figure demonstrated by past performance - the more vulnerable it becomes to possible miscalculation and serious error."

    We conclude with an emphatic quote by Warren Buffett, which captures the essence of the entire argument as best as we possibly can. He says, "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).

     

     

    Equitymaster requests your view! Post a comment on "The type of investment you should definitely avoid". Click here!

    6 Responses to "The type of investment you should definitely avoid"

    bansalkl

    Oct 18, 2009

    Timely and neatly summarised article about IPO
    Pricing is very crucial.
    Retail investors should be thankful to u.

    Like 

    Balasubramanian K

    Oct 18, 2009

    Your article is timely and highly informative. Many companies are rushing to get the SEBI-nod for their IPO ,obviously at highly irrational premium,to wipe out a part of their imaginary losses and to sell their present holdings of company shares and cheaply-bought lands at astronomical prices to their company, in the case of realty-companies. SEBI has proposed to come out with guide-lines for IPO-pricing,but only after a delay of over 6 months,so that these companies can get away with their loot,from an easily-gullible and small-investors ,ignorant value-based and return-based investment. Earlier SEBI had miserably failed to protect investors from many highly priced IPOs like ReliancePower,Uttam Sugar etc, to quote a few, which are now available at abysmally low prices, with no prospect of a dividend in the foreseeable future. Many investors don't even read newspapers like ET, which aim to caution them from such day-light robbers,looting the investors of their savings,with SEBI looking aside with connivance that cannot be proved. The MOF must direct SEBI to put on hold all DRHPs ,till it comes out with their guide-lines. Heaven will not fall on them if these companies are made to wait a few more months, but investors will be saved.Can we expect SEBI & MOF to act atleast now in their only role to protect uninformed investing public ?

    Like 

    santosh

    Oct 14, 2009

    Congratulations on a nice article.This has come at a right time as market is expected to be flooded with IPO's in coming days.

    Like 

    Sarda Ram Karsania

    Oct 13, 2009

    13th Oct.2009
    Valuable advice given to the investers at the right time.
    We should be morecareful in investing our hard earned money.
    Thanks and regards.

    Like 

    K. Sankara Narayanan

    Oct 10, 2009

    Your advice on Investment to be avoided has come at an appropriate time & is a Wake up call to gullible retail investors.
    Oil India is an exception and IPO's of PSUs are to some extent an exception as no group is going to profit from it.
    Rating of new issues needs to be made mandatory.
    We retail investors are thanful for this timely RED SIGNAL.

    Like 

    abc

    Oct 7, 2009

    Excellent article. Neatly summarizes Buffet and Gharam's thoughts. I really like your ever cautious approach towards investing that you keep suggesting to everyone. Keep up the good work.

    I would also like to see one article from your side on Shares with Differential Rights given their dismal performance in India.One more on Right issues if you can manage. All these instruments are anti investor but sold to general public at huge cost. Irony is that like in case of IPOs, it is public which funds commission of I-Banks because their cost is also included in IPO proceeds expected by company. Amazing structuring these bankers do to fill their pockets depriving millions of investors.

    What I found missing in above article was role of HNIs and FIIs who dump share on the listing day itself onto general public. Though concept of Anchor investor is a better one but not sufficient to address the root cause of the problem. Hope you would shed more light on these aspects in your next article.

    Happy investing!

    Like 
      
    Equitymaster requests your view! Post a comment on "The type of investment you should definitely avoid". Click here!
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Why Hasn't Warren Buffett Rung the Bell Yet? (The 5 Minute Wrapup)

    Aug 22, 2017

    It's surprising Warren Buffett hasn't warned investors about the expensive stock market? Let us know why.

    Think Twice Before You Keep Money In A Savings Bank Account (Outside View)

    Aug 22, 2017

    Post demonetisation, a cut in bank savings deposits rates was in the offing.

    A Darkness Is Spreading Across the US (Vivek Kaul's Diary)

    Aug 22, 2017

    Today, we are attacked by one preposterous thing after another, each of them even more absurd than the last.

    Dear PM Modi, India is Already Land of Self-Employed, and It Ain't Working (Vivek Kaul's Diary)

    Aug 21, 2017

    Most Indians who cannot find jobs, look at becoming self-employed.

    More Views on News

    Most Popular

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE SENSEX


    Aug 22, 2017 01:06 PM

    MARKET STATS