Neil Parag Parikh, chairman and CEO at PPFAS Mutual Fund, cautions investors against the IPO trap..
I started my career in the capital
markets in the year 2004. The bull phase had just begun in 2003 due to
economic growth of the country improving and there was a subdued
optimism when I began my journey.
The next few years saw the market
picking up steam and reaching its peak in 2007 right before the subprime
crisis ended the party in 2008. This period also saw a large number of
Initial Public Offerings (IPOs) hit the market.
As the market crashed and remained
lackluster, so did the IPO market. We witnessed a V-shaped recovery in
2010-2011 and yet again we saw the IPO market heating up. The next few
years saw the stock markets in a bearish phase and this led to the IPO
market drying up. As the Narendra Modi government came to power in 2014,
we saw the market react positively and that started another bull run
for the markets. This again coincided with a record number of IPOs
hitting the markets in 2015-2016 and continuing till today.
Notice any pattern? I bet you do!
| Year | Number of IPOs | Amount (Rs/crore) |
| 2015-16 | 74 | 48,927 |
| 2014-15 | 46 | 3039 |
| 2013-14 | 38 | 1236 |
| 2012-13 | 33 | 6528 |
| 2011-12 | 34 | 5904 |
| 2010-11 | 53 | 35,559 |
| 2009-10 | 39 | 24,696 |
| 2008-09 | 21 | 2083 |
| 2007-08 | 85 | 42,595 |
| 2006-07 | 77 | 28,504 |
| 2005-06 | 79 | 10,936 |
| 2004-05 | 23 | 12,382 |
| Source: SEBI Annual Reports | ||
Let us try to understand the economics of an IPO.
A company intending to raise resources
for expansion and acquisitions would like to go for an IPO. Or a group
of initial investors desiring an exit would also opt for an IPO. When
the company is selling shares to the public, it would want the maximum
possible price for its original investors and risk takers. So most IPOs
come out in a bull market when prices are high and irrational investors
are willing to pay any price for owning stocks. The greed and
overconfidence of investors are so strong during bull markets that they
will be willing to buy anything at any price. Thus, promoters of the
company prefer to dilute their stake when they are hopeful of getting a
handsome price for their shares due to bullish market conditions. This
further leads to some unscrupulous managements to come out with IPOs to
cash in on the current IPO boom and take advantage of investor greed.
This is due to the fact that if
investors have made money in a couple of IPOs then other IPOs (which are
probably not of good quality) become representative of profitable IPOs.
Investors blindly chase IPOs. This herd mentality creates huge demand
and the IPOs tend to get oversubscribed. This demand- supply mismatch
may create a profit for the investors on listing due to the prevalent
market conditions. But as the listing euphoria dies down, so do the
prices of many of these IPOs.
Today’s IPOs are offered at market
prices. In the past, India had a Controller of Capital Issues (CCI) to
decide the pricing of IPOs. This made subscriptions of IPOs very
profitable and investors made handsome returns then. But today if you
have to pay the market prices, then there is a huge choice for you.
There are over 7000 stocks listed and available at market price. Then
why would one want to invest in something that is already priced high?
It is absurd to assume that IPOs are offered to the public at a bargain,
as IPOs don’t come in bear markets. Also, for human beings, the
penchant for chasing the new is so strong that investors do not see the
reality and blindly chase IPOs.
Let’s take a look at an example of this behaviour.
Let’s go a little back in history during
the technology boom in 1999-2000. Again a host of IPOs entered the
market. All a company had to do was to affix ‘dotcom’ after its
name to have investors willing to pay crazy valuations. We all know how
this ended. Most of these IT companies have been delisted or have
disappeared altogether resulting in massive losses to investors.
Another example is during the 2007-2008
real estate and infrastructure boom. A host of IPOs of these sectors hit
the market to try and take advantage of the current conditions. Most of
these have fared quite poorly since then. Let’s look at three of the
big IPOs that hit the market during that time and their return as on
January 31, 2017:
- Reliance Power: Down 91.84% from listing price
- DLF Ltd: Down 76.70% from listing price
- HDIL Ltd: Down 89% from listing price
(Source: Economic Times)
There are a host of other real estate and infrastructure companies that had the same fate as the above.
My basic argument is that, if one is
lucky, one can come across a few IPOs where one can reap immense
benefits. However, there are too many IPOs where one can get trapped and
can lead to massive losses.
Be careful when you see a host of IPOs
hitting the markets as they are looking to get the maximum price out of
you. Investing is all about paying the right price for an investment, to
reap long term healthy returns.
The above views are personal and not necessary those of the organization the author represents.
Source: www.morningstar.co.in
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