Should you invest in an IPO?

IPOs create a lot of excitement amongst investors. Business newspapers & T.V channels make it a point to tell you how "advisable" it is to subscribe to this new offering. So let's find out the hard facts behind these IPOs

"It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)."

                                                                                  - Warren Buffett

There is a lot of wisdom in that statement. Let's analyze the characteristics of an IPO to better understand the insight that Buffett is offering us -

Characteristics of an IPO

IPOs arrive only when the market is extremely expensive - Suppose you own a property that you want to sell, considering there is no emergency, when would you like to sell it? Will you sell when the real estate market is booming and the prices are rising or, will you sell when the market is depressed and you are unlikely to get a good price?

The answer is obvious, everyone wants to sell when there is a boom and you are likely to get a good price. Similarly, an IPO is an event when the promoters of a company are diluting their stake. They would naturally want to do it at the maximum possible price. IPO is for the benefit of the promoters, they are looking to making money, they are not bringing the IPO to help you get a bargain !

Let's look at the chart below to substantiate this point

Credits - Chittorgarh.com

Notice the number of IPOs in 2013 & 14 when the market was not doing well. No company was willing to dilute its stake in such a market. But as soon as the markets started rising, everyone wanted to take advantage of the opportunity and gather money from the public. Ask yourself - Do you really want to be a part of this?

IPOs are sold by knowledgeable sellers (Merchant bankers & company insiders) to the common investor - Merchant bankers are paid to price the IPO as high as they can while ensuring that it is subscribed. It is a part of their job to ensure that a company receives maximum valuation in an IPO.

Hence, they are certainly not concerned about whether the public is getting a fair deal or not. So, the entire concept of IPOs is designed to favor the seller at the expense of the buyer. Ask yourself - Do you wish to be that Buyer?

Restrict yourself to the companies that are already listed - Isn't it weird that out of the thousands of listed companies that are traded everyday people find the one that is coming out with an IPO to be the most attractive one.Why is the company that is coming out with an IPO is worthy of your money and not the companies that are already listed?

Attracted by listing Gains?

Media usually hypes the listing gains that you can get. Yes, Some IPOs do rise 20-25% on the day they are listed. So, it is assumed that you can earn Lacs of rupees through it in a single day.Firstly, a retail investor can only apply for maximum 2 lac Worth of shares, but sadly since most of the IPOs that provide listing gains are oversubscribed multiple times, you will be lucky to get 1 or 2 lots. So, you are alloted Rs 15,000 to 30,000 worth of shares (if you are lucky).

Now even if the share rises 20% on the listing day, your profit on the investment of Rs 15,000 is going to be Rs 3,000. Huh! all that hype around the IPOs for a 'chance' of earning 3,000? Of Course - the mainstream media was never interested in telling you this harsh reality.

But it gets worse! More than 50% of the IPOs actually list at a discount to their offer price! We don't get to read about them because the financial industry chooses to keep silent about them.

So here is how you can get listing gains

Apply for an IPO

Hope that it oversubscribed many times (only then will the listing gains be good)

But ironically, if it is oversubscribed many times, you will not get more than 1 or 2 lots

So you are only allotted shares worth Rs 15,000-30,000 (if you are lucky)

Hope that the listing is at a good premium (50% chance)

If all the above mentioned happens - YIPPEE! you just earned Rs 3,000!

And we thought IPOs were good for us!!