IPO: Should you bite the bait? - Views on News from Equitymaster

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IPO: Should you bite the bait?

Nov 27, 2003

Brokers and other market players are never short of 'tips', be it a bull market or a bear market. The most popular 'tip' that is doing the round these days is, "Blindly invest in IPOs (Initial public offers) and make money". With the buoyancy seen in the stock market in the recent months, one may once again see a spurt in the number of IPOs coming to the market. But does subscribing to an IPO always guarantee returns? Let's find out. IPOs are a means for a company to raise resources to fund its various business needs. However, it is also a very useful medium for unscrupulous promoters of fundamentally weak company rob innocent investors of their savings. To justify the above point, take a look at the following table.

Performance at glance...
Company Date of listing Price on listing Current price Gain (%)
Divi's Lab Mar-03 176 996 465.2%
i-flex Sep-02 296 717 142.3%
Bharti Tele Sep-02 34 81 137.4%
Maruti Jul-03 164 328 99.6%
Indian Overea Bank Sep-02 28 29 4.3%
Uco Bank Oct-03 20 17 -11.0%

The table above indicates that in a majority of cases IPOs have been rewarding for investors. While companies with a good business models are bound to outperform, companies with a weaker business models or a poor management are unlikely to yield any return whatsoever. Bharti Tele-Ventures Limited (BTL) is one the India's leading private sector telecommunication service provider with presence in various segments of the industry. Despite incurring losses, the prospects for the industry going forward, and the purpose for which the IPO was made (raising funds for acquiring new circles) augured well for the company. Similarly, in case of i-flex, its banking product, 'FLEXCUBE' has been well received globally. This apart, the scalability of the product translated into strong business prospects for the company. Resultantly, we see that investors who subscribed to these IPOs were well rewarded for their decision.

On the other hand, investors who would have invested in the two banking IPOs (Indian Overseas bank and UCO Bank) would have seen nothing but disappointment. Indian Overseas Bank and UCO Bank both scored poorly as compared to its PSU peers on most operational parameters. This apart, both banks had also received poor reports from the Reserve Bank, thus raising questions about their credibility.

Thus, investors need to realise that, 'investing in IPOs guarantees assured returns', is only a myth. Only a fundamentally strong company with a good business model and a proactive management is likely to perform well. Investors need to hence make a detailed review of the company before applying to an IPO. The purpose for which the company is raising the funds and its cash flows should be looked into. This apart, the P/E of the company vis--vis its peers should be calculated before subscribing to the IPO, as it will be a good indicator for ascertaining whether the IPO is fairy priced.

In a bull market, investors will have many IPOs coming their way. In the next few months many companies including Tata Consultancy Services (TCS), Indraprastha Gas Ltd. (IGL), Biocon India, NTPC, etc are likely to venture into the primary market. Investors hence need to be choosy and undertake a thorough study before applying to an IPO. Taking the advice of experts (basically research based outfits) in the field would be definitely of help.

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