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Want to invest in IPOs

By Sanjay Kumar Singh
January 20, 2021 09:32 IST
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Check the company's business model.
Businesses with high moats -- a competitive advantage that is hard to breach -- should be preferred.
The financials must be strong and consistent, suggests Sanjay Kumar Singh.

Kindly note the image has only been posted for representational purposes. Photograph: Kind courtesy Gino Crescoli/Pixabay
 

Taking advantage of the current bullish market conditions, companies have raised Rs 15,774.2 crore (Rs 157.74 billion) via initial public offerings (IPOs) between September and December 2020.

The pipeline remains strong and another half a dozen issuers could launch their IPOs with offerings worth around Rs 8,000 crore (rs 80 billion) in January.

Investors must do due diligence before investing in them.

Watch out for risks

One key risk in IPOs arises from asymmetry of information.

"The party selling the shares has more information about the company than the investor," says Jimeet Modi, founder and chief executive officer, Samco Securities.

Companies often do IPOs right after they have reported strong quarterly results.

"Investors extrapolate recent performance into perpetuity and become willing to pay a high price," says Modi.

Sometimes growth appears elevated because of a low base.

Says Sarvesh Gupta, founder, Maximal Capital and a Securities and Exchange Board of India-registered investment advisor: "In the case of companies that have been listed on the exchanges for long, investors can look up their performance over several business cycles, allowing for better assessment."

Risk also arises from the life-cycle stage of these companies.

"Many of them are still young. Their brands are not well established and their market share is low. These factors make them riskier than blue-chips," says Ramabhadran Thirumalai, associate professor of finance, Indian School of Business.

Very little may be known about the promoters.

"Sometimes, investors do not know how competently they will run the company and whether they will protect minority shareholders' interests," says Thirumalai.

The biggest risk comes from high valuations.

"IPOs can be successful only amid buoyant market conditions. Prices tend to be high in such conditions. This is what makes it riskier to invest in them," says E A Sundaram, chief investment officer, o3 Capital.

In the case of many recent IPOs, says Modi, valuations were 2x the ones commanded by listed peers, even though the debutant's fundamentals were not better.

When should you invest

Study each IPO in detail and invest if you are convinced of its merit.

"When a well-managed company with a leadership position comes out with an IPO for which no quality peers are available within the listed space, one may invest in it," says Modi.

Well-established brands provide safety.

When Indian Railway Catering and Tourism Corporation did its IPO, it was a well-known brand that had been around for many years.

In some cases, there could be a major private-equity investor that is a shareholder.

"Such institutional presence provides comfort that the company would be observing a minimum standard of corporate governance," says Gupta.

Checks you must run

Check the company's business model.

Businesses with high moats -- a competitive advantage that is hard to breach -- should be preferred.

The financials must be strong and consistent.

Next, compare the valuations with those of listed peers.

"Understand whether the company doing the IPO has better or worse prospects than other listed peers and then decide whether the valuations make sense," says Gupta.

If a company can enjoy high growth for a sustained period, it is okay to pay a high price for it.

If you like a company but find it expensive, wait 200 days after the listing.

"By then it would have reported three quarterly numbers. You will have a better sense of whether the numbers reported at the time of the IPO are sustainable," says Modi. "Two hundred days are also sufficient for genuine price discovery to happen."

Feature Presentation: Aslam Hunani/Rediff.com

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