IPO mania is here again. But as a Moneylife research study shows, there is only one way to play the game. Debashis Basu, Sanket Dhanorkar and Pratibha Kamath explain. Plus a survey of readers’ opinion on key issues regarding IPOs

It is that time again when companies queue up to raise heaps of public money from primary markets. With stock markets trading tantalisingly close to their historic peaks, the upbeat market mood is perfect for taking a splash in the money pool. After all, the opportunities in the wake of a booming stock market are simply too mouth-watering for promoters to ignore. We have already seen a flurry of activity in the primary market which is threatening to turn into a glut.
 
CFOs will be hard at work to dress up the company financials and present a rosy picture to investors. Investment bankers will be spending countless hours managing disclosures in prospectuses and planning a marketing blitz around the issues. Promoters will be smacking their lips in anticipation. After the dust settles down on this party, the promoters and bankers will have fattened their wallets while clueless investors will be left licking their wounds, baffled at the steady fall in post-issue price. But, if you have the stomach for it, there is a way you can turn the tables on the promoters and beat them at their own game. 

Putting it simply, there can be three options for you as an investor in IPOs. IPO performance data over the past three years shows that one of these is a winning strategy and the other two are not. Here is an analysis of investment in IPOs under the three options and what could have been your returns in each case.

Scenario 1: Staying the course
‘Buy and hold for the long term’ is a strategy often advised to investors who wish to earn decent returns on equity investments over the long term. It does make sense to follow this strategy for picks in the secondary market, because one is able to buy high-quality stocks at a reasonably low price from time to time when the market crashes and also as long as one is not married to the scrip. But anyone bringing this idea to the primary markets is running a fool’s errand. Investors who had bought at the issue price and held their investments in their portfolio would be staring at large losses. Here are the bare facts. A whopping 60 out of the 107 companies that have listed in the past three years are now trading below their issue price! A 44% chance of making money on one’s investment is hardly encouraging. Of these 107, only 12 are still showing a price appreciation of 100% or more (as of 20th October) while 23 stocks are trading at less than a third of their issue price.



The average return investors would have earned had they invested in all 107 public issues would be 15%. The Systematic Investment Plan over three years in an index fund would have earned you almost double that amount. Even this 15% is due to a high degree of skewness. Some issues that have done exceedingly well are clear cases of price-rigging and manipulation. Indeed, the median return on investment for the buy-and-hold investor in this scenario would be a pathetic -4%. So, if you are looking to buy at the time of issue and sticking to your guns no matter what, you are essentially playing a zero-sum game. It could pay rich dividends if you know about stocks that would be rigged up in the secondary market. Else, you could find yourself in a very deep hole.

Among the IPOs that stand out, Kiri Dyes & Chemicals is now quoting at a 316% premium to its issue price. Midfield Industries and Bedmutha Industries have run up 224% and 174%, respectively, over their issue price, within a matter of weeks. Our market sources whisper of market manipulation with ease. Meanwhile, stocks like Bang Overseas and Resurgere Mines & Minerals India have tanked 76% since the issue. Even stocks from supposedly high-growth sectors, like KSK Energy Ventures and Gammon Infrastructure Projects, are trading 28% and 31%, respectively, below their issue price.

Scenario 2: The Sitting Duck
What would be the outcome for someone wanting to get in at the time of listing of the stock and holding on to his investment? The situation would be grim, to say the least. Out of the 107 public issues over the past three years, as many as 65 are now trading below their listed price! This means investors have only a 39% chance of getting something back on their investment in this scenario.
 
Looking deeper, we observed that 30 stocks are now trading at less than a third of their listing price while only a handful of stocks have witnessed a price appreciation of more than 100% since listing. Worse still, had you invested in all of these 107 companies at the time of listing, you would now be sitting on a paltry 4% average return. Of course, this figure would have been even lower but for a few stocks that might have been manipulated, generating higher returns. The median return on investment in this scenario is a frightening -14%! Essentially, an investor making an entry into the stock on listing day is no better off than a duck during hunting season.



As we said, a handful of stocks have exhibited robust growth even after listing. These are among the small breed that have worked their magic on the back of that rare combination: low offer price and robust earnings growth. Prominent among these are Jubilant Foodworks (up 209% since listing), Rural Electrification Corporation (up 180%) and J Kumar Infraprojects (up 129%). Among the recent issues to have hit the market, Aster Silicates, Tirupati Inks, Emmbi Polyarns and Tarapur Transformers have turned sour since listing. What could be the reason behind such measly returns post-listing? For that, we need to delve into the third and last scenario—the listing-day phenomenon.

Scenario 3: Playing the Flipping Game
Ask any smart investor the reason for wanting to invest desperately in an IPO. Almost always, the answer will be: gains that come by flipping on listing. The price pop that is generally associated with the listing of a stock is why investors are so attracted to an IPO. Numbers support this. An astounding 95 stocks that hit the market in the past three years got listed above their issue price. This means that an investor has an 89% chance of adding value to his investment on the listing day itself. On an average, these stocks would have yielded investors gains as high as 11% had they exited at the time of listing. As many as 44 stocks have yielded more than 10% on listing. To put things in perspective, out of the 15% returns that investors have so far clocked on the issue price of these stocks, 11% was captured at the time of listing itself! This means that almost 75% of the gains were accounted for at the time of listing. This explains why the returns post-listing were so abysmal, at least in the past three years.



Among the stocks that have seen a substantial pop at the time of listing: DQ Entertainment, with a massive 69% price pop, followed by Career Point Infosystems (49%) and NMDC (46%). DQ Entertainment and NMDC have, since, suffered a plunge of 13% and 37%, respectively, while Career Point Infosystems has inched up 7%. Interestingly, companies that have tanked dramatically since listing showed a substantial jump on listing day. Future Capital Holdings, Rishabdev Technocable and Tirupati Inks were among those that got listed at a huge premium and went downhill subsequently.

The Inconvenient Truth
So what should an investor do? The obvious conclusion one can draw is that there is only one way to make money from a public issue—to play the promoters’ own game, but play it even better. And that is to flip the scrip—get in and out before all hell breaks loose. Remember, the Reliance Power IPO debacle? The stock opened at a 22% premium over its issue price, but now finds itself down 54%. Although we do not recommend investors to practise such a strategy, this is the unfortunate truth. Investors seem better off playing the shorter format of the IPO game rather than testing their mettle in the longer format. That is what most investors look to do—hit a six and get out instead of grafting a painful innings out in the middle.

But this is the very nature of the primary market, as we have pointed out several times in the past. To put it simply, IPOs are a typical bull market phenomenon and at that time pricing goes haywire. As we have seen in 1994, 2000 and, recently, in 2007, a rush of IPOs happens only when things look extremely rosy. A persistent and untrammelled rise in stock prices has always attracted a flood of IPOs. It is then that investment bankers collude with companies to stick expensive stocks on you. This keeps happening in cycles—IPO mania is at its peak during booms but new issues are conspicuous by their absence when the market is down for a prolonged period. In the bear phase between February 2008 and 2009, only 33 issues came up for listing. However, the phenomenal rally since March 2009 has brought in its wake 74 public issues till date.

Toss in a hot stock in a bull market and the stock should do well, right? This is where one essential feature of the IPO market comes into play, almost guaranteeing that you will lose money: You have no choice over the price you pay. It is promoters and investment bankers who decide the time and price for their public issue that suits them the best. And they are only interested in the highest possible price. A bull market is a seller’s market. This is why IPOs can rarely come cheap your way. But that is the very reason while prices unravel in the post-issue phase. All the issues that have failed were not only hit by the changed market climate but also by unreasonably high pricing. That is the nature of the IPO game. So, the lesson is simple. Avoid IPOs if you can and if you are, indeed, tempted to subscribe, flip it on the first day. IPOs are rarely more than one-day wonders.