Saturday, August 8, 2009

IPOs: To invest or not to invest?

IPOs are a magnet for the retail investors. The question which begs to be asked is to invest or not to invest? The NHPC IPO is ongoing.

Lets try and understand why companies come up with an IPO?

Companies need capital to grow their businesses. The capital can be in the form of equity or debt. The companies cannot keep taking debts. There is a ratio known as Equity to Debt ratio. This means the money put in by investors as against loan taken by the company. The cost of debt is high. One has to pay interest on the loans taken. Companies usually come up with an IPO when the market is bullish. The idea is to raise the maximum amount of money by diluting the least amount of equity.

Where does the Retail investor feature in here?

A fixed portion of the IPO is reserved for the retail investor. IPOs bring in new businesses to list on the markets. The problem with IPOs is retail getting very little allotment.

The Positives:

1. New businesses like, retail, power, infra get listed and the investors get a chance to invest.

2. Get a share in the business at a price lower than what the market price would be.

3. Entry point for a long term investor.

4. Assured allotment (If you invest for 1 Lakh)

The Negatives:

1. Even if one invests the maximum 1 lakh, if the IPO is heavily oversubscribed one gets only shares worth Rs 10000, which may become Rs 15000 on listing.

2. The amount of shares got is so negligible that it makes no difference to one’s portfolio

3. If one is looking for listing gains your blocked money gives you a gain of 5 % on the 1 lakh locked. Investing it in say a blue chip may give you more amounts in same time. (Remember it’s a bull market)

4. If it’s a mega IPO. Market may tank while listing (Remember R Power)

5. The valuations are absurd. (There is no free lunch anywhere in the world)

The best strategy would be to make a note of such companies and buy them during market corrections at lower than IPO prices. Stocks IDFC, Yes Bank, Mundhra Port was available at below IPO prices later on.

NHPC IPO, I read that EPS is Rs 1 giving a P/E of 33-36. I would avoid investing in it. The power companies are currently the darlings of the stock market. This is because there is a power shortage in India. So every MW you generate will find a buyer. 3 years later on when all the power comes online, we would eventually be a power surplus country. That time the tariffs would fall down. So all the projections go for a toss.

IPOs could be treated as a entry point into a company. Get a small quantity allotted, and then eventually add to the stock during market corrections.

Personally, I usually avoid all IPOs.

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