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Chapter 14: Challenges in IPO investing

The short-term strategy of flipping (the next chapter explains this concept) your shares is com-monplace in the trading world. Most people expect to make considerable gains on the listing day. The fact that companies like Salasar Techno and Avenue Supermarkets made blockbuster market debut with 152% and 114% gains fuels traders’ hopes of such a thing happening all the time.

However, retail investors should not get lured by the riches tales only. They need to read the warning signs as well. So, let us look at some of the challenges retail investors face while bid-ding for an IPO.

  • 1) Lack of enough information

    Retail investors may not have access to adequate information to make a well-informed choice of investing in an IPO. That’s because independent research and management evaluation be-come difficult in this case. The company’s prospectus is put up on SEBI’s website but retail in-vestors may find the text difficult to understand. One would have to be a financial expert to understand the nitty-gritty of a company.

  • 2) Fragmented broker landscape

    Even the largest of brokers may not have enough links with all the underwriters in the market. This is a disadvantage because the best way to buy shares in an IPO is through the underwrit-er’s retail broker network. Underwriters usually give these brokers a higher number of shares.

  • 3) No guarantee of listing gains

    History has shown that the biggest companies have floundered in an IPO. For instance, L&T In-fotech IPO had a lukewarm response from the market in 2016. ICICI Lombard is another exam-ple. Although Lombard received a good response during the IPO — it was oversubscribed by three times — it listed 2% lower than the issue price of Rs 661.

  • 4) Actual gain may be low

    Let’s take the example of Salasar Techno. That IPO was oversubscribed 60 times in the retail quota. If the company decided to allot shares to all retail investors, one would get shares worth not more than Rs 3,300 even after applying for the full Rs 2 lakh. The Rs 2 lakh amount is blocked up to eight to 10 days.

    Due to the appreciation of the company’s stock on the listing day by 152%, a retail investor would make Rs 5,000 (roughly Rs 1,700 profit) if s/he decided to sell the shares. And since the listing gain is subject to a short-term capital gain of 15%, the actual gain would be much lower. It would be even lower if the stock does not appreciate by that much on the listing day. Re-member, Salazar Techno’s market debut was an extraordinary event. In the ordinary world, a lot of fresh stocks don’t necessarily appreciate by that much.

  • 5) Extracting true value

    Say, an IPO share that cost Rs 100 went up to Rs 150 in a few weeks’ time. You may think there’s a profit of Rs 50, but if you think about it, the company may have undersold itself. It means that the company could have raised more capital to expand its operations and conse-quently, its long-term profitability. Therefore, gauging value of a successful IPO can be a bit tricky for a retail investor. This challenge, however, concerns people who buy IPO from a long-term perspective and not those who are looking to make a quick buck.

    As mentioned earlier in the piece, in case the IPO is undersubscribed below 90%, the shares are forfeited and the money is refunded.

    The taint of undersubscription can affect any company. For instance, Google, one of the technology giants, has also faced this issue in the past. Back in 2008, Google were compelled to slash the share price from the original $108-135 a share to $85-95 per share. In the end, it fixed the price at $85 per share due to low demand.

One of the ways that can help you through tricky IPO investments is to consider an actively managed fund (Kotak Securities provides this facility). Such funds deploy professional teams who can advise people about the merits and demerits of investing in different IPOs.

A quick recap

Before you invest in an IPO, try and look for answers for the following questions:

  • Is the company capable of giving handsome listing gains?
  • Does my portfolio allow me to allocate Rs 2 lakh in order to get maximum allotment?
  • What will be the cost incurred for blocking funds for 8-10 days?
  • What will be the cost incurred for blocking funds for 8-10 days?

If you have answered the above questions in the affirmative, it is clear you are ready to invest in an IPO. The next step, therefore, is to bid for an IPO.

What next

The following chapter will discuss the strategy of flipping.