Imagine if you had invested Rs 9500 (100 shares at an issue price of Rs 95) in the public offer of Infosys Technologies in 1993. After adjusting for all the stock splits and bonuses over the years, your investment would now be worth Rs 29,440,000, an appreciation of a staggering 3,000 times in the 14-year period, not including the dividends that the company has paid. A host of such successful IPOs such as Bharti Tele-Ventures (issue price of Rs 45), Indiabulls (issued at Rs 19), including recent ones such as Everest Kanto Cylinders (issue price of Rs 160), Educomp Solutions and Tech Mahindra have turned in stupendous returns over the years.
Though investors often look upon initial public offerings (IPOs) as a moneymaking exercise and focus on listing gains, it pays to evaluate IPOs from a long-term perspective. A look at the factors that should be considered while buying into an IPO.
Don't go by subscriptions alone: More often than not, investors base their decisions on the subscription figures received by the offers. Given the IPO stampede that we are seeing now, the subscription figures do tend to influence listing gains, but may not be a good guide to the long-term prospects of a company. Subscription numbers are often a function of market conditions at the time of the offer. Even a good IPO may flounder in a declining market, while a fly-by-night company may rake in the money if the market is in good shape. As a long-term investor, you need to evaluate an IPO from the point of view of whether you would like to buy into the business for which funds are being raised.
Don't go by absolute price: Do you believe that an IPO priced at Rs 10 is a safer bet than one priced at Rs 1,000? Not really. In fact, focussing only on IPOs with a low absolute price may leave you with a portfolio of companies with barely any credentials. Companies with a track record of good financial performance would already have a reasonable level of earnings and are likely to price their IPOs at a high absolute price. When evaluating IPOs, try and get an idea of the valuations, or how the offer price discounts the company's potential earnings, rather than its absolute price. If the overall outlook for a sector and a detailed assessment of the company's prospects vis-à-vis its peers appear positive, even high-priced IPOs could turn out to be a good bargain. Offers of companies such as Suzlon Energy, AIA Engineering or even the recently listed Info Edge or Sobha Developers have been among the top-performing ones in recent times, but none of them would have caused a blip on your radar if you were looking for IPOs priced below Rs 100! In hindsight, these offers were a steal at their issue price, given that they listed at a substantial premium and have never touched the offer price levels again!
The business at a good price: IPO investing is based on the belief that investing during the offer gives you an opportunity to get a bargain price for that company. After all, why park money in the public offer at a fixed price, when the same stock would be available on the tap in the secondary market in about a month's time. Thus, valuations should play an important role in influencing the decision to invest in an IPO.
For instance, consider a company X, which is slated to make an IPO. Assume you are convinced about the company's business model and the management's ability to successfully steer its progress. In other words, you believe that investing in the company could provide good returns. At such a stage, the only factor that might influence your decision would be the valuation of the price. Is the offer priced at a discount, at a par or at a premium to its peers? If at a premium, do you think the business really offers something new or unique that justifies the premium? Answers to questions such as these should influence your assessment. If you feel that the offer is priced stiffly, you can safely stay way and consider investing through the secondary market at a later date.
Don't base decisions on listing performance: Like subscription numbers, a stock's returns on the day of listing are also often a function of short-term factors such as market conditions at the time of listing and the near term results expected from the company. Investing in any IPO locks your money for nearly a month. If during the lock-in period (the time from application until listing), the market crashes, your stock's debut could be lacklustre. If you have bought into an IPO because you believe that the project has the potential to deliver healthy growth over the long term, have the conviction to stick with your choice. Bharti Air-Tel, which saw its stock plunge below its offer price on listing, has turned out to be one of the strongest wealth creators in recent years.
Investing in IPOs, much like investing in the secondary market, requires considerable effort on your part. But if you are worried about missing out on such offers as that of Infosys Technologies, you can be rest assured that the chances of such a miss are now minimal, in the light of an improved market efficiency and the coverage most offers get from various analysts and brokerage houses, which can supplement your own efforts.
With IPOs becoming more frequent and institutions getting more selective in choosing between them, listing gains on every IPO are no longer a given. Therefore, every investor must be aware of the general market trends and the nuances of basic research. For, in the world of investments, if such ignorance were considered bliss, then bliss could be very expensive!