Sunday, January 9, 2011

Making money in IPOs

Initial Public Offerings (IPOs)are a great opportunity for promoters to sell shares at a very high price and for the investing public to make some listing gains if possible. Buying a stock that has just got listed after an IPO is a foolish idea. While a Moneylife study has proven this (Read 'How to play the IPO game'), here is one more evidence. The BSE IPO index has performed badly since its launch on 24 August 2009. The index closed at 1947.54 on the day of its launch. On Friday, exactly 16 months since its launch, the BSE IPO index was at 1,908.90, down almost 40 points. In the same period, the Sensex is up by 28%.

The Bombay Stock Exchange (BSE) launched the BSE IPO index to track the value of the companies listing subsequent to a successful completion of an IPO. The index currently has 72 companies. But this figure is continually changing, depending on how many companies are listed, as an IPO company is kept on the index only for two years.



What does the poor performance of the IPO index indicate? Simply that one should avoid buying a stock after listing, especially when the IPO pipeline is robust. When the BSE introduced the BSE IPO index, it hoped to capture "the current primary market conditions in the Indian capital market and measure the growth in investor's wealth within a period of two years after listing of a company, subsequent to successful completion of an initial public offering (IPO)." As the index shows, there has been no "growth in investor's wealth" post-listing. The BSE, like everybody else blindly assumed that investor's wealth usually grows post-listing. This happens only in exceptional circumstances-when IPOs are made in a depressed market.

The BSE went on to argue, "robust growth of the Indian economy, 6.7% in 2008-09, and the expectation of higher growth in the future are expected to boost the primary market. For this and other reasons, it was an appropriate time to introduce to the market an indicator that will track primary market conditions in the Indian capital market." The "boost" in the primary market that the BSE is talking of is only the exorbitant high prices at which promoters are able to sell their IPOs, making sure that the index does not perform, contrary to the BSE's hopes!

Moneylife spoke to a few experts, all of whom said that high valuation of the IPOs is the main reason for the poor performance of the index. "Most of the IPOs come with high valuation. So there is a possibility that a majority of them will not give much returns," said the vice-president of the research unit of a leading brokerage firm who requested anonymity. This view was echoed by Rajesh Jain, executive vice-president (retail research), Religare Securities Limited: "High valuations are one of the main reasons for the index to fall." He argued that the movement of the secondary market was another reason for the downtrend in the IPO index. "Since its launch, the BSE IPO suffered a small dip then remained steady. From March 2010, it went up and did well till mid-September, reaching almost 2,340 levels. In November, there was a sense that the market would correct. This took a toll on the IPO index and it's been down since," Mr Jain explained.

According to Vivek Mahajan, head of research with Aditya Birla Money Ltd, over the past couple of months, most of the IPOs which have hit the market have performed miserably, including government sponsored ones. Aggressively high valuations of IPOs is leaving nothing on the table for investors. This is the reason for the poor performance of the index.

The fact is that, usually, IPOs are bad bets if you buy them after listing. The Moneylife study 'How to play the IPO game' (a research and analysis of 107 companies that have listed in the past three years), concluded that investors should avoid IPOs after listing. In the report we provided three scenarios for an investor to invest in IPOs, out of which only one is a winning strategy and the other two are not.

The first option, 'Buy and hold for the long term', leads to losses. According to our research, 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.

The second option, 'Buy at listing and hold on to the investment' again doesn't help. Our research suggested that of the 107 public issues over the past three years, as many as 65 are now trading below their listed price, giving investors only a 39% chance of getting something back on their investment in this scenario. This explains why the BSE IPO index is down.

The third option, which is a wining strategy, is 'Playing the flipping game', that means subscribing and then flipping it on the first day. Our research showed that an astounding 95 stocks that hit the market in the past three years got listed above their issue price. This gives the investor has an 89% chance of adding value to his investment on the listing day itself.
Source : Moneylife.in

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