IPO myths

Lots of investors who may have subscribed to the initial public offers (IPO’s) are under the impression that they strike a goldmine when the IPO lists at a premium. But this may not be entirely correct.

Promoters’ wealth swells when the shares list at a premium as in most cases they have a majority holding. But whether the IPO listing has been profitable for retail investors can be understood from the following illustration. (In this study, only companies that have floated their IPOs with issue price above Rs 100 per share in calendar year 2007 and listed at a premium have been considered.)

Suppose a person invests Rs 1 lakh (the cap for small investors) in IPOs of two companies. Let us select from our sample a company whose shares ended with the highest premium on the day of listing, and a company whose shares closed with the least premium.

Everonn Systems’ shares settled with the highest premium on day 1, while DLF’s shares closed with the least premium.

By investing Rs 1 lakh in Everonn Systems’ IPO, the investor would have effectively applied for 714 shares. But because of the huge subscription of 123.80 times in the retail segment, he would have been allotted only six shares. The profit on day 1 would be Rs 338 per share (difference between close price and issue price). The investor would have made a total profit of Rs 2041 (Rs 338* 6 shares). The return on investment (ROI) in this case is just 2.03% (i.e., Rs 2041 earned on investment of Rs 1 lakh).

However, when the same investor puts in Rs 1 lakh in the DLF IPO, he would have applied for 190 shares and got full allotment of 190 shares as the retail portion was subscribed just 0.97 times. The profit on day 1 would be Rs 45 per share (difference between close price and issue price). The investor, thus, would have earned total profit of Rs 8550 (Rs 45* 190 shares). The ROI in this case is 8.55% (Rs 8550 earned on investment of Rs 1 lakh).

From this comparison it is seen that a retail investor with an investment of Rs 1 lakh earned 4.19 times more profit in a company which settled with the least premium on day 1 than the company which settled with the highest premium on day 1. Effectively, this means besides listing premium, oversubscription has an impact on investors’ return on investment. Higher the oversubscription lower is the return.