Myths about investing in IPOs
updated on 21 Sept 2016
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If you thought that making money in initial public offerings (IPO) was the secret wealth-creating formula, then you may be wrong! IPOs are more seasonal in nature and we usually see them rushing to D-Street in a bull market--like the one we are in right now.

After a blockbuster 2015, it looks like 2016 won't disappoint investors with that extra risk appetite. Since the beginning of 2016, 17 companies have already filed their IPOs and got listed on stock exchanges.

The IPOs in India are set to hit a six-year high in 2016, and are estimated to raise over $5 billion (Rs 33,500 crore), says an EY report. In the year 2015, 21 firms raised over $2 billion (Rs 13,400 crore) from the equity market.

Indian market touched 18-month highs earlier this month, and chances are that, as fears of global risks recede, market would resume its upward trajectory and support the IPO market.

The following are top 5 myths about IPO

Myth 1: All IPOs are high-risk, high-reward:

History tells us that in bull markets, even mom and pop businesses dole out IPO. With bullish sentiments at play, most issues get heavily over-subscribed, just like the ones we have seen in the last two months.

The stocks get listed at substantial premiums to the issue price and investors who are lucky to get allotment make a killing on listing. That sounds just like a fairy tale, right?

The real threat to retail investors comes from the mispricing of IPOs when greedy promoters charge excessive premium for the issues.

In 2015, the IPO of a popular international brand listed at a huge discount to the issue price impacting retail investors. On the other hand, a quality issue from the aviation space, which turned out to be a successful issue, didn't see good retail participation

Therefore, investors should be choosy while applying for IPOs. If investors apply only for reasonably priced issues, there is no risk.

Myth 2: Liquidate existing investment to invest in IPOs

To abandon a tried and tested, rewarding, long-term partner for a new kid on the block doesn't seem like a great decision. If a story is such a high conviction story that it should be invested into, it will remain so even post the listing day, experts suggest.

If we check the last few years IPO performance data, out of the 148 companies, 59 companies have delivered positive returns, while other 89 companies have delivered negative returns.
Therefore, it is important to research the company's business model on various parameters before investing and one should definitely avoid liquidating good existing investments just to make a quick buck

Myth 3: If a company is going public, it must be a good company with strong financials

Sebi regulation makes it mandatory for companies to have a track record of distributable profits under Section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years.

One must keep in mind that not all companies that go public may have strong financials. "On the contrary, some of them may be in dire need of money, which is why they opt for the IPO route

IPOs should be treated like any other company share already listed on the exchanges. If it is an exceptionally well-run business and is offering quality product or services, better than its peers, it is bound to outperform.
Myth 4: Newly listed IPO is likely to outperform its peers


During an IPO frenzy, it is possible that new listings might outperform their peers. This happens in speculative mania associated with the IPOs.

"Premiums in the grey market might contribute to this frenzy. But, this will only be a temporary phenomenon. Good quality stocks of established companies with a proven track record will always be good friends of the investor,

Unfortunately, we don't get IPOs of differentiated businesses very frequently. One such old example is Infosys, which got listed on exchanges way back in 1990 and was the leader in the IT space. After about 14 years, its competitor TCS got listed.

"Both TCS and Infosys are competitive companies with strong financials, quality management, and good business models. Today, when we look back, Infosys has delivered around 410 per cent absolute returns compared with around 845 per cent TCS' returns, since the listing of TCS (Sep 2004)

In this case, TCS (IPO) has outperformed its peer group company. But, there are a number of companies, which have underperformed their peer group companies (after their IPOs). One such example is L&T Finance The company got listed in August 2011 and delivered about 88 per cent absolute returns since then, compared with its existing peer, Bajaj Finserv's which has given 475 per cent absolute returns in the same period.
Myth 5: If everyone's excited about the IPO, it must be a good investment

These days, many people are forced to believe that if the brokers, advisors and analysts are positive on any IPO company, it should turn out as good investment only, which is not true.
The biggest mistake to is following the herd mentality. So, if everyone is talking about it, everyone is buying it! Still, the IPO may not be a must buy.

When big investors and investment banks back an IPO, they have vested interests. When a company goes public, it opens up a more liquid market for them to sell

Investors should never get carried away by the IPO flood. Without consulting your investment/equity advisor or doing your own research, it is best to stay away from any such issuances.