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Home > Business > Special

How to earn well from IPOs

Vinod K Sharma | September 29, 2007

Initial Public Offers (IPO) usually present a good investment opportunity for the retail investor. And for a greenhorn, who is making his capital market debut, IPOs are the vehicle of choice.

In each public issue, 25 per cent of the shares on offer are reserved for the retail investor. A retail investor is defined as any individual who applies for less than Rs 1 lakh.

The chances of allotment for a retail applicant are pretty high as compared to the HNI or QIB category. In the recent Power Grid Corporation of India issue, the allotment was 15 out of 100 for the retail, whereas in the HNI category, the allotment ratio was a measly 2 out of 100.

The second advantage is that the retail applicant is allowed to apply at cut of price in a book-built issue, a prerogative the other classes of investors do not enjoy.

While the other categories have to specify the price within the given band, the retail investor's application will be considered valid at whatever price the issue gets ultimately allotted, provided he opts for the cut-off price and writes a cheque for the full amount.

While the dice is loaded in favour of the retail investor, he will still do well to do his proper homework. Keep in mind a few simple points detailed here and relish the joy of picking the low-hanging fruits of IPO gains.

How is the issue priced? What's on the table for you? Are you being served just crumbs or Apple Pie?

Why does the company need capital? If money is used for expansion, will business genrate enough returns to reward new stakeholders?

Is there a better secondary market option? Always compare with the listed peers.

Are the promoters withholding the golden goose or cashing out ? Is there a group company in similar business competing for the business with the proposed listed player?

Look out for otherĀ  businesses or companies that may compete with the listed company.

Are there any legal issues pending against the promoters orĀ  family members?

Always check the pedigree of investment bankers and lead managers associated with the issue.

If possible, read prospectus, especially for risk factors.

That does not mean that investing in IPOs is a risk-free activity. They come with their own pitfalls.

One of the pitfalls is that the sentiment could change from the time the application is made and shares are ultimately listed. This time lag could work to the advantage of the applicant as well, if the sentiment changes for the better.

While the retail response to the DLF IPO was lukewarm, the stock did well on its listing as the sentiment for real estate changed for the better in between.

When a issue gets heavily subscribed, the chances of allotment even in the retail category will diminish. On the other hand, an issue that does not receive adequate response may fail and the money may have to be returned to the investor resulting in the money being invested, without commensurate returns in the first case and without any returns at all in the second.

There is no guarantee that the stock will list at a premium to the issue price, even if the issue is over-subscribed. This is the biggest risk that investors face. Once you put in an application, your money gets blocked for a around three weeks.

If you are a secondary market buff, that would mean giving up on those trading opportunites that may present themselves during the period.

Make a habit of keeping records of whatever application you put into any initial public offer. Registrars are known to bungle in popular IPOs where large numbers of applications need to be processed in a short span of time.

All told, retail investors will continue to flock to IPOs like a duck takes to water. And it is these large IPOs like Power Grid, with their high-decibel advertising and excellent credentials, that bring in the fresh batch of first-time investors to the markets and the successful allottees get to stay back in the secondary market.

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