Be It Markets or IPOs: Watch for Valuations This Festive Season

Kotak Insights | Date 03/11/2023

Let’s get real for a minute here.

There’s a high chance you got into an IPO and regretted it later.

You may have been enthused by its colourful advertisement, or by the numerous advantages listed in its red herring prospectus.

Initial public offerings (IPOs) are marketed as a great way to capitalise on new opportunities.

You see, there’s always some excitement in the markets when a new company enters the fray. And the excitement gets overhyped when the company is a relatively established one.

Investors believe they’re getting shares at reasonable valuations in an IPO.

But in reality, that’s not the case always.

When the sentiment is running hot, and there are a lot of crazy narratives spinning around, retail investors forget that sentiment-based investing is a shoddy approach.

The hot tech IPOs we saw in 2021 and 2022 are proof of this. Companies like Paytm, Zomato, among others, saw blockbuster responses when they launched their offers.

The sentiment was so good back then that despite them being loss-making companies, they garnered significant attention and got the valuations they asked for.

And you already know what happened next – shares of these companies were beaten down sharply as they weren’t able to scale their business as per market expectations.

As things stand now, we believe it’s time for a reality check for the Indian share markets and some upcoming IPOs.

October 2023 was a reality check for the Indian markets. While markets are rattled with geopolitical uncertainties surrounding the Israel-Hamas war, interest rate changes, potential Fed tapering and rising bond yields, among other reasons, have kept the markets on their toes.

While all this is happening, one of the most hyped IPOs of 2023 - Mamaearth IPO (Honasa Consumer Ltd) – successfully garnered funds and sailed through on the last day of subscription.

Earlier this year in January 2023, reports were circulating suggesting that the company is seeking a valuation of Rs 24,000 crores via its IPO sometime this year.

If the company had decided to come out with its IPO seeking the exact valuations, the repeat of Zomato or Paytm was imminent.

But gladly, it decided to value shares at a price band range of Rs 308 to Rs 324, which, at the upper end, values Mamaearth at nearly Rs 10,500 crores.

Most experts still say that the IPO is priced aggressively.

That could be true for some reasons.

The company has reported a loss of Rs 151 crore in the financial year 2023.

Looking at the IPO details, most of its existing investors are offering their stake. The promoters, early-stage investors, and the brand ambassador are selling.

And, lastly, there’s intense competition in this space, with players like HUL, Godrej, Emami, and the likes capturing a large share of the pie.

Even Nykaa is present in this space, and the company was recently listed on the bourses.

The takeaway here is simple - no matter how promising a company appears, overspending on its stock could not be a good choice at all times.

The inherent risk in IPOs lies in their unpredictable valuations. As these companies debut their shares in the open market, the stock price remains uncertain until the moment it's revealed on the bourses.

The IPO serves as just an initial entry point for investment. A more conservative or calculated approach would be to hold off until the company's long-term trajectory becomes more apparent or the stock's valuation reaches a more reasonable level.

Here again, there’s an example of the same stock mentioned earlier – Zomato.

For astute value investors, shares of the food-delivery company were untouchable two years ago when it came out with its offer at high valuations. However, after a 60% fall in the year following its IPO, there were clear signs that the fundamentals of Zomato were improving as the company started to become profitable at earnings before interest, tax, depreciation, and amortisation (EBITDA) levels.

Eventually, it became profitable every quarter, much before its earlier projection. Since then, the stock has rebounded and found many takers.

Regardless of a company's strengths, buying its stock at an inflated price isn't wise.

In conclusion, buying into an IPO is an exciting prospect. Even if you miss out on getting allotment at the time of the IPO, you can still get it after it’s listed on the stock exchanges, given that valuations are in line with expectations.

Also note that this might not be the case for every IPO and investors and traders should surely subscribe to them after evaluating the risks and rewards and the individual investing profile.

Coming to the overall market’s valuation, the Sensex PE ratio is flashing red. Based on trailing twelve months' earnings, the PE ratio is close to the 22x mark, against its long-term average of 16-17x.

For a better perspective, some of the biggest crashes in India have occurred when the Sensex PE ratio was hovering between 25x-28x, which means we’re not in dangerous territory right now.

While it makes perfect sense to be apprehensive about investing in the current market, pundits have been calling a crash for months. Based on fundamentals, the chances of that happening look very slim.

This article gave you insights into the overall market sentiment and valuations and also some takeaways about how to go about investing in upcoming IPOs.

Do keep these points in mind the next time you’re trading or investing.

Until next time…

Stay Tuned!

Sources: Kotak Securities, BSE, Moneycontrol

Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.