Tips For Investing In IPO

Most good IPOs are in demand and therefore, oversubscribed. That’s a problem — not for the company but for investors. That’s because it becomes extremely difficult for an investor to get the desired number of shares.

Here are are few things you can keep in mind incase an IPO is oversubscribed.

Allocation Process

Before discussing the strategy to maximize the allocation of shares from an IPO, it is imperative that one understands the allocation process.

Before October 2012, retail individual investors (RII) were allocated shares proportionally in case of oversubscription. This meant that people who bid for higher lots had a greater chance of allocation, as against smaller investors.

This gave an incentive for high net-worth individual (HNI) investors to enter through the RII route to bid for IPOs.

SEBI was not happy with this and mandated that starting October 2012, all RII applications will be treat-ed equally.

This means that when an IPO is oversubscribed, shares are allocated by drawing lots and each chosen applicant is allotted one lot of shares at a time.

This also means that if the number of applications are more than the number of lots available, no ap-plication will be allotted more than one lot.

If the number of applications are less than the number of lots available, each applicant will be allotted at least one lot, and the remaining lots will be decided by lottery.

So, the questions that now arises is how to ensure you have a greater chance of getting shares during the allocation process. The following are some of the strategies you can put to use to increase your chances.

• Fill the form correctly:

First and foremost, make sure that you fill the application form correctly and are not rejected on technical grounds. This may sound obvious, but consider this: During the IPO process for Advanced Enzyme Technologies, a total of 785,165 applications were made for 375.059.792 equity shares. With a quota limit of 1,599,565 shares for RII, the issue was over-subscribed by 11.35 times. But after technical rejections, this came down to 11.122 times.

• Make cut-off bids:

Consider an issue with the price band of Rs. 90-100. Now, if you make a bid at Rs. 95 and the discovered price is Rs. 98, your bid will be rejected. Therefore, the optimal strategy in such a case is to make a bid at the highest possible limit of the price band. But RIIs have an even better strategy available - make cut-off bids instead of price bids. For this, simply select the right checkbox that says cut-off bid. This will ensure that your bid will be honored at the discovered price regardless of what the bid price entered.

• Make as many applications as possible:

Since all applications are treated equally, the optimal strategy is to make as many applications as possible with different demat accounts. You could do this by either asking all your family members to apply or by using multiple demat accounts for the purpose.

• Avoid last-minute rush:

While applying later is a good strategy, as this allows you to gather da-ta based on bids already submitted, do not wait until the very last moment to submit your ap-plication. Doing anything in haste can backfire. Give yourself some breathing space while sub-mitting the bid.

Heuristics

While it is clear that you must make multiple applications when an issue is oversubscribed, the other question is how many lots should you apply for in each application.

Here, you will find some heuristics to help you decide the right number.

As a rule of thumb, it is better to apply for an issue that is oversubscribed rather than under-subscribed one. One way to ensure you are allocated shares in times of oversubscription is by applying for an IPO by 2pm on the third day on the following two occasions: The high net-worth individual (HNI) investor segment is oversubscribed by at least 9 times, Retail individual investor (RII) segment is oversubscribed by at least 10 times. If oversubscription is less than 10 times, apply for the full Rs 2 lakh-limit. This is because a 10-time demand is on the lower end of an IPO oversubscription. Therefore, such a scenario will still give you a decent chance of multiple lots being allotted. If oversubscription is more than 10 times but less than 15 times, apply for five lots. If oversubscription is more than 15 times but less than 40 times, apply for two lots. If oversubscription is more than 40 times, apply for one lot per application, as chances of get-ting more than one lot are practically non-existent.

What If You Still Get The Desired Number Of Shares?

Despite following the aforementioned strategy, it is still possible that you may not be allocated any shares.

This is when you need to be patient. Avoid buying stocks on the listing day, i.e., the day when a com-pany’s stocks makes its markets debut. Since a lot of in-demand stocks “overheat” on the listing day, it is not an ideal time to buy.

If you analyze the share prices of companies post-listing, you’d find that more often than not, a steep decline can be seen after a few months.

This typically coincides with the expiration of the lock-up period associated with the offer. During the lock-up period, insiders like employees and officials of the company cannot sell their shares. This peri-od varies from three months to 24 months, based on the agreement with the underwriters. As soon as the lock-up period ends, most of the insiders decide to book profit, resulting in the market being sud-denly flooded with shares. This puts a severe downward pressure on the share price.

Therefore, if you miss out on the IPO, wait for the lock-up period to elapse, provided the fundamen-tals of the company are strong.

A Quick Recap

Luck is a huge factor during the allocation of shares in an IPO. But there are strategies that can reduce the role of chance in such cases. It is also important to remember that a good stock will always remain a good stock. Therefore, avoid investing in a stock that has just made its debut on the stock exchange. Stock prices are usually high on the listing day. Instead, bide your time. Wait for the stock price to drop before you put your money on it.