Quite a few IPOs are lined up and have been coming thick and fast in recent times. And more importantly, many of them are witnessing significant oversubscriptions. That in itself is a clear sign that appetite for IPOs is rising as the markets themselves. Investing in IPOs does look glamorous and good to talk about. But it can be tricky if you don’t understand what the realities are.
Sometime back, I wrote an article titled Why are IPOs Overpriced + come in Rising Markets. This might be a good time to remember a few things about IPOs:
Why IPOs Are Overpriced?
If I own a company that is about to go public with an IPO – which means I need to sell my shares to get money – then I and everyone else in my IPO team will do everything to ensure that we get the highest possible rate for each and every share that we want to sell via the IPO. Isn’t it? This is not about being greedy on our part. This is just what any normal person will do. And that is exactly what a promoter (original Investor) does during an IPO.
For a moment, let’s digress from IPOs and assume that you want to sell your house or any other piece of real estate. You will definitely try to get the maximum price for your house, isn’t it? You would not be concerned about the buyer’s welfare at all. Don’t feel bad about it. It’s natural. Everyone wants to get more when they are selling. But you don’t want to be at the receiving end of such a seller’s transaction.
Similarly, even the promoter of the company is selling his shares to new investors (i.e. you, the IPO investor). As already mentioned, his primary aim is to get the maximum amount of money for his shares. He, with his investment banker friends, sets the issue price. Remember that he still has his primary aim in mind, while setting the IPO price band. Now as an IPO investor, you end up paying as much as the promoter wants – i.e. a lot more than what might be financially necessary.
Here is what the noted financial writer Jason Zweig says about IPOs in his interesting book, The Devil’s Financial Dictionary (link):
“…greatest opportunity to the insiders who are selling…”
Yes. That is how IPOs are designed to work. For the promoters and early investors.
Why IPOs come in Rising Markets?
During bull markets, the perception of stock markets being a place of easy money becomes strong. This in turn helps IPO sellers to sell the IPO as dreams to potential investors. Investing in IPOs during bull markets can still be a profitable endeavour. But then again, IPOs during rising markets get hugely oversubscribed and allocation is pretty small.
Many people suffer from the Fear Of Missing Out (FOMO) syndrome, which pushes them towards IPOs. They put money in IPOs with the hope of making some quick gains. But for most people, hope is not a good strategy. If you are lucky, you might make money. But odds are stacked against common investors in IPO.
I think sometime during 2020 when HDFC Bank had completed 25 years, there were stories floating around about how an investment of Rs 1 Lakh in HDFC Bank IPO became Rs 8-9 crore in 25 years. It is indeed true. Just like the Amazon IPO success story (link) that was about how in 1997, Amazon’s IPO was priced at $18 per share. In 2020, Amazon was trading around $3100-3300 per share.
No doubt every now and then, some or the other IPO will give supernatural returns. Either on the day of listing and/or over a period of time. But these are far between and exceptions. The actual norm is pretty different. Most IPOs don’t make much money for small investors. The stories being told at the time of IPO can only remain true for some time. Eventually, the business reality will catch with the story and the price. And then, you already know how such stories pan out and eventually end.
Remember that the IPO stories are meant to attract new investors. And IPOs are built around such stories and exaggerated hypes. That’s it. Very soon the mega LIC IPO is scheduled to come to market too. It will be a big event in the IPO market and it will be interesting to see what stories are built for the issue then.
In general, IPOs are only launched keeping in mind the interest of existing promoters and investment bankers. There is a reason why they tell you to read the offer document carefully before investing. 😉
If you are a long-term investor, you are better off looking for good stocks in the already-listed space.
I am sure that many people will still be interested in investing some money (say sin money) in IPO. I am not stopping you. Please go ahead and do it.
To be fair, there have been some good issues in the past and its possible that good companies might come up with an IPO that is worth investing in. But identifying the ‘goodness’ of the company in itself is a very big task. Most IPOs are not good for most investors – and hence, there is no reason for common investors to try and portray that they know the value of the company better than the person who is selling his stake in the IPO.
If you like dabbling in IPO markets for fun with small amounts of money that won’t hurt you if you don’t do well with it, then it is perfectly fine. But if you are looking at primary markets and IPOs seriously and perceiving them as lottery tickets, then be cautious. During times like the current ones when markets have run up a lot in quick time, even the poor-quality IPOs tend to see tons of over-subscriptions and create a perception of a once-in-a-while kind of opportunities.
Nevertheless, what I have written here is the actual reality of the IPO. You can still invest in them if you wish. But do understand that in reality, it is just a hungry know-all promoter looking to get some money from common people who basically know nothing about the business.
If you are capable of investing in direct stocks, then its better to find stocks of good businesses available at reasonable valuations in the secondary market itself. For those who aren’t much into direct stock investing, it’s best to get yourself a financial plan and invest regularly in line with their risk appetite and financial goals.