Look beyond the call of IPOs

For a stock to be a good long-term bet, it needs to be backed by a strong business and be available at reasonable valuations

Seven months, 25 issues. 80, 100, 120% in listing-day returns. IPOs this year are a starry lot! If you were among those that received allotments in IPO applications and made good money, you’d be sitting happy. But if you didn’t apply or weren’t allotted any shares, don’t bemoan the missed opportunities. Here is what you should know about IPOs.

No sure-shot returns

IPOs are sought after in the belief that they serve up return opportunities that you won’t find in ‘older’ or existing stocks. But does that pan out in reality? Not quite. Let’s take it from two perspectives.

First, the purely fundamental perspective – that is, looking at an IPO based on its business strength and growth prospects for long-term holding. On this count, long-term returns for IPOs do not boast of anything special, with most of them putting up mediocre performance. Those that have delivered multifold are few. Over the past 15 years, there have been roughly about 325 IPOs. Of these, almosty half are below issue price i.e, in the long term, they have been poor performers.

Prospects always depend on the business itself and the valuations at the time of the issue. For a stock to be a good long-term investment, it needs to have a strong business and you need to buy it at reasonable valuations; this means you also need the freedom to wait for business prospects to improve or the right valuation to come by.

In an IPO, you control neither aspect. It’s logical that the company will try to maximise issue proceeds and will price it accordingly – and IPOs that come in bull markets, such as now, can get away with pricey earnings multiples. Therefore, many IPOs slip post listing because their pricing left little on the table for long-term investors.

Second is the listing-gains perspective. Recent IPOs such as those of Tatva Chintan Pharma, GR Infraprojects or Zomato have seen exuberant listing, with listing day gains of close to or over 100%.

Listing gains, though, are a factor of the market scenario, how fancied the IPO is in context of the market scenario — and more than a little luck. While the IPOs mentioned above grabbed the headlines, plenty others, which also debuted in the same market and saw good subscription interest, put up sedate listing performances. KIMS Hospitals, India Pesticides and Shyam Metaliks, for instance, saw listing gains of below 30% while those such as Kalyan Jewellers or Suryoday Small Finance Bank dropped.

If you’re viewing IPOs from this lens, remember that betting on listing gains is more a speculation than an exercise rooted in analysis of fundamental strengths or valuations. Apart from the wide range of post-listing returns, it is hard to say beforehand what a stock does on listing day. Oversubscription, institutional interest or even grey-market premiums are not sure-fire ways to gauge what listing returns can be. A turn of market mood between the IPO launch and its listing, for example, can dampen even fancied themes.

Finally, there’s no way to know if and how many shares you will receive in IPO allotments. Small allotments will have no meaningful impact on your wealth creation.

But if you’re looking for IPOs where the business strength is sound and which can be part of your stock portfolio, then all you need to do is bide your time.

Second chances

IPOs that have made good money for investors haven’t always been on an upward trend. Consider V-Mart Retail, which today has delivered a 41% CAGR from its issue in 2013. That stock had almost halved from its issue price just six months after listing. The post-listing period, therefore, offered plenty of buying opportunities. The company was also able to showcase its ability to keep revenue growth up and skirt around the troubles that dogged other retail players.

Post-IPO periods help give a deeper understanding of how a company performs across business cycles – something that is hard to gauge from an IPO prospectus that gives limited data on historical performance. Several other IPOs that have gone on to create wealth such as Galaxy Surfactants, Rail Vikas Nigam, Aavas Financiers, Fine Organics and Mishra Dhatu Nigam, all dropped post listing.

But even if IPOs don’t correct, that does not mean there are no investment opportunities. Companies with sound businesses can be buys, and valuations buttressed by steady earnings accretion, even if prices don’t correct after listing. Take Jubilant FoodWorks. This stock hasn’t dipped below its 2013 issue price – but it has made money even for those who got in much later. Other examples include Dr. Lalpath Labs, HDFC AMC, or Sheela Foam.

The more recent crop of IPOs – those that have come over the past couple of years – have certainly offered slightly more differentiated opportunities. IPOs of AMCs, small finance banks, retail and consumption and so on, for instance. But when business strength is sound, the secondary market still offers the grounds to pick these up.

Watchlist

Put simply, IPOs offer no special opportunities. Stocks that shoot through the roof on listing are more an exception than the norm. So, if you identify a good business in an IPO, go right ahead and subscribe. But should allotments be low or nil, don’t sweat it. Add these stocks to your watchlist and bide your time to enter.

(The writer is Co-founder, PrimeInvestor.in)

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