Investing in a ‘star’ IPO? Look past the bling and read the fine print

Last week, this writer received a marketing call from a private sector bank. “Ma’am, if you start a demat account with us you can invest in the Zomato IPO that’s opening shortly,” said the bank employee. He pushed it just a little further: “It’s the year’s most anticipated IPO.”

This is but a sample of how mainstream initial public offerings (IPOs) have become for lay investors. While some companies such as Zomato have certainly garnered more interest and excitement than others, IPOs are no more the niche investment instruments of institutions or well-informed retail investors.

But how safe is the money you put in an IPO? How and when can you expect returns? These are questions you should ponder over before filling the application forms.

Ignore the euphoria

“There is always euphoria created around IPOs. One should not get carried away. Investors, especially new ones, should not rush to grab IPOs,” said TR Somasundar, whose company Shilpa Associates manages over ₹120 crore of mutual fund (MF) assets.

“Most IPOs are at a premium to face value. You must be able to convince yourself about this (before buying in),” he told The Federal. “Perhaps they (lay investors) do not have the wherewithal to understand the business and the management quality.”

Also watch: Zomato IPO: How shares are allocated

A classic example would be the IPO of Uber. The cab hailing firm launched a public issue in May 2019 and, amid massive investor frenzy, sold 180 million shares at $45 apiece. As soon as the company was listed post-IPO on the NYSE, the first shares were traded for $42 apiece. By the end of the day, they fell 7.6% to sell for $41.57 each.

This means, the initial euphoria around the IPO could not sustain the Uber scrip. The stock did appreciate subsequently, but those who sold their holdings soon after the IPO made only losses.

It’s not all doom. Homegrown IT services firm Happiest Minds Technologies had an issue price of ₹116 per share when it launched its IPO last year. Since then, the scrip has soared nearly 600% and, today, it’s nearly ₹1,493 a share. That presents a tidy jackpot for the IPO investors who held on to their shares.

While institutional investors are built to cushion such declines and surges, individual investors often aren’t.

Listing gains not a sound target

Finance experts suggest that retail investors avoid rushing to buy a stock during its IPO, with dreams of seeing it zoom after listing. If at all you invest, do so because you strongly believe in the company’s credentials and business model, have confidence in the sector it operates in, and expect your money to grow steadily over the long — or at least medium — term.

Also read: Why cash-hungry start-up giants turn to IPOs for sustenance

“Investing in IPOs for listing gains alone is strict no,” said Somasundar, who is also a Bengaluru-based stockbroker. “If it is not worth holding, it is not worth buying.”

It would be prudent to apply a few basic questions to your IPO investment plan. The investment goal assumes significance here. If it’s for a short-term goal such as a holiday next year, an IPO is not a sound option.

Even if the company’s fundamentals are good, it may take a while for that to reflect on its stock price. The vagaries of the stock market can work either way on your money, so go for IPOs only if you don’t need returns on that investment immediately.

“For a committed investor, there are always good shares in the market to buy. Chasing IPOs for a kick may not be worth the while,” said Somasundar. “Learn a bit about fundamental analyses and technical analyses. You will end up buying rewarding scrips.”

Factors to consider

If you are, however, keen on an IPO, you can participate in a specific issue if that company balances out your existing portfolio. For instance, if your portfolio is loaded with large-cap companies operating in traditional sectors, such as SBI or Tata Steel, investing in Nykaa’s IPO (if it takes place) may be a good strategy.

The sector makes a difference, too. If you’re convinced that digital payments are here to stay, the Paytm IPO may offer you the perfect opportunity to turn your belief into an investment. But again, you need to go beyond the sector and look into the company’s specific pluses and minuses.

For this, the Draft Red Herring Prospectus (DRHP) that the company files with the market regulator comes in handy. It is in the public domain and contains all the details of the IPO-bound company — its promoters, location, financials, operations, existing investors and so on.

More importantly, the company is mandated to state in the DRHP what it sees as future threats to its operations — a careful read will expand your knowledge not only on the company but also its peers. The DRHP goes through third party audits, so that lends it adequate authenticity. The print tends to be small and the sentences long-winding, but don’t let that deter you.

Pay attention to the company’s promoters and investors. If they are staying invested in the firm post-IPO too, that could be a plus for you as an investor, for they continue to have skin in the game. The IPO of a government-owned entity may seem super-safe, but exercise caution there, too, for there is always the possibility of it being taken over later by a private entity.

Viable alternatives

Somasundar said even if retail investors are convinced about an IPO, they will end up with very few shares if it’s a ‘good’ company. “Good issues are always oversubscribed. You may get a pittance of the allotment, if at all. If you are convinced about the company, buy its scrip if the listing price is reasonable.  Else wait for a deep market correction and buy it in reasonable quantity,” he said.

Further, he suggested, those who are keen on IPOs can invest in them via MFs. “There are mutual fund schemes available today which invest only in IPOs — analyses them (the stocks), holds them, and buys more of them at the perfect time. Outsource your headache to them,” he added.

Somasundar has a word of caution for individual investors: “Please remember — for every Happiest Mind or Nazara Technologies (a gaming firm that has seen robust gains on the stock market post IPO), there are 10 other dud issues in the IPO market. Tread carefully.”