Finding Mangoes Among Lemons in the IPO Market

Finding Mangoes Among Lemons in the IPO Market

Amid the ongoing IPO frenzy, here is a guide to help you pick the right one.

Picking the right IPO (initial public offering) in equity market is never as easy as it looks. Sophisticated marketing and advertising hides the risks that a smart investor can check before investing.

Companies have of late made a beeline to list on the bourses in the hope of making the most of the improvement in market sentiment. However, not every new issue is worth your hard-earned money.

Soft interest rates, improved corporate earnings, the government's promise on improving ease of doing business and efforts to uncomplicate the taxation structure have all created a conducive investment climate and perhaps improved retail investors' confidence in equities once again.

A market starved of big IPOs in the last several years has finally garnered Rs5,727.81 crore through this float route in the first three months of the current financial year. This makes it a nine-year high.

But Prithvi Haldea, Chairman and Managing Director of Prime Database, says: "Two to three IPOs a month is not a boom. The issue size of many companies is also very small. So, there is still a lot of room for upside."

A good indication of this upside is the number of issues in the pipeline. These include 16 small to medium issues worth Rs5,345 crore. Some nine larger ones, from ICICI Prudential Life Insurance and PNB Housing Finance, are still pending with SEBI for approvals. It's estimated that these would garner another Rs13,414 crore, according to PRIME Database.

Even if you think that IPOs are a route to make quick money, you must be in the right lane. So, amid this frenzy and flurry of IPOs, how should the retail investor play his cards?

Here are seven basic rules to help you choose from the clutter.

Don't go by hearsay

Tips and recommendations are great but you must be confident that your money is going to make its way back into your wallet. So, web-search the company for basic information, read various media reports about it and pick up the narrow font type black and white prospectus that can put you to sleep.

Track down the players Liking the management and their philosophy is important. You don't want to be sailing under the guidance of someone who is unsure of his business or who is not transparent about his company's history or funds deployment in the future. Be wary of who is selling their stake too! Often private equity players or venture capitalists use the IPO route to exit.

Know how will your money be used

If you give a loan to a friend you always want to know why he or she needs it for. Similarly, you need to know how is the management going to deploy the funds it is raising through the IPO route. This will help you estimate whether your precious money stands a chance to grow, and if yes, then how soon!

Do fair price valuation

A correctly-priced company will always have better chances of a fair listing. One method is book-built pricing where investors decide the cut-off price, which falls between the floor price and the cap price. IPOs in the initial phase of a bull run are generally good due to the more cautious strategy adopted by underwriters and merchant bankers. In the tailwind, its often greed that operates.

Compare it to listed peers

Pick up stocks with the same business, look at their stock prices, and find their earnings ratio. This will help you decide whether the company going public deserves to trade on similar valuation multiples. The two most basic components for comparing could be the book value and operating margins. For example, L&T Infotech numbers could be compared with that of TCS and Wipro.

Find out how long will your money last

Is it a business where the company needs fast funding? If it's capital intensive and the returns are slow, it could mean that there would be an FPO, a follow-on public offer, too. They will be back to raise more capital. There might be a risk that they will not be able to raise the capital and die. However, for PSUs in India, stake dilutions are done through the FPO route, and that's not worrying.

All that glitters is not gold

Renowned broking firms or promoters backing the float is no guarantee that the IPO and your investment will be a success. One has to be cautious as broking firms are executing the role of a salesman to retail investors. Example: The RPower IPO had the backing of Enam Securities and promoter Anil Ambani but it gave dismal returns on listing. In fact, even now, the stock is trading at a 90 per cent discount to the listing price.

So, remember, don't buy a stock only because it is being sold through an IPO - do it because it's a good investment.