As the reform expectations bring retail investors back to the markets, a new wave of confidence has taken over companies that are ready to raise money this year. The IPO pipeline, after almost drying up in 2013, saw some activity in 2014. As such, 2015 has already seen five IPOs so far.
Now, investors during such times need to be very cautious. Usually, increasing activity in IPO is a sure sign of an overheated market. It should come as no surprise that giant public issues tend to coincide with market tops. When there is so much hype and hoopla in the IPO market, most of these primary issues tend to get mis-priced. The companies, coming out with IPOs, look to capitalise on this euphoria and command premium valuations. This is even when earnings growth and financials do no support such high prices. It is much evident from the historical data that the IPOs have destroyed the most shareholder wealth!
Therefore, what we believe is that IPO investments could be one of the riskiest classes of equity investments that a retail investor can make. This is because one is betting on a company which is still testing the waters. Plus we have very limited financial information and no access to management meetings.
Hence investors should not get carried away by all such noises. We would like to point out that the discipline that one needs to follow when investing in listed stocks also applies to IPOs. In others words, the investing process for both the secondary and the primary market should not be different because of the hype created about a particular IPO. Investors need to judge the moat of the business, the sustainability of profits and management quality of the businesses offered through the IPO route. Just like one does for companies which are already listed.
IPOs typically offer exit routes to promoters and early investors. Hence unless the issue is very attractively priced, these hardly leave enough valuation upside on the table for investors. And it is always advisable for investors to understand the business model and management quality thoroughly before investing.