Is it the right time to invest in public issues?

After remaining dormant for several quarters, the primary market is showing signs of revival. A slew of public issues is slated to come out in the coming months, much to the delight of the market participants. “The revival of the primary market is a positive sign because it reflects the improving sentiment. If any of the bigger issues turns out to be successful, it will enhance the sentiment further,” says Vibhav Kapoor, group CIO, ILFS.

The forthcoming public issues can be broadly classified into three categories. The first lot includes IPOs of companies that were waiting for the sentiment to improve before tapping the market. Among these are some mega IPOs, including Bharti Infratel. The next set has PSUs that have been put on the block by the government. The third category comprises private-sector companies with a very high promoter holding. These companies have been asked by Sebi to reduce their promoter holding to 75% before June 2013. They may launch FPOs or take the new offer for sale (OFS) route offered by Sebi.

Will this supply of new shares suck out the liquidity and bring down the overall market? Perhaps not, at least not in the near term. Experts believe there is no rush. “There is a pipeline of issues, but this can’t be called a rush. The companies are still deferring the issues because they are not able to get the right price,” says Prithvi Haldea, chairman and managing director, Prime Database.

However, this does not apply to PSUs and companies that have been asked to reduce their promoter holdings. The decision to go public has been forced on these companies and they have to act in a time-bound manner. The increased supply may bring down the prices of individual stocks.

Invest or leave?

For investors, the big question is whether to invest in the new issues. Though there is a lot of hype surrounding public issues, the IPOs that have come out in the past two years have not impressed with their performance, with the BSE IPO Index underperforming the broader market (see graph).

Theoretically, the best time to invest in a stock is when it is about to start with its growth trajectory . So, IPOs give you an opportunity to participate in the growth prospects of that company. However , the reality is that investors can lose heavily if they put their money in overhyped IPOs.

Why do investors get excited about IPOs? First, unlike other stocks that are already listed in the market, IPOs are pushed by the company’s management , merchant bankers and brokerages. So, there is a concerted effort to market the shares. Second , some recent IPOs have given excellent returns, even though several others have failed to live up to the expectations.

The problem is that when stocks are doing well, a lot of IPOs flood the market, and it is important to separate the chaff. The consumer product companies have been leading the market rally for the past 2-3 years and, therefore, it is natural that those like Tribhovandas Bhimji Zaveri and Lovable Lingerie feature in the list of winners. The pharma sector is another hot sector now and this explains why Aanjaneya Lifecare is in the list.

A good IPO is one that is priced reasonably, leaving enough on the table for the investor. Coal India was one such issue, which created wealth for investors despite the sectoral and regulatory headwinds faced by the company. So the rules for evaluating an IPO are no different from choosing a stock in the secondary market.

Since most IPOs will hit the market with a lot of hype, it is possible that retail investors get carried away. Here are some danger signs to watch out for:

Exit strategy for promoters:

Be careful if the IPO is an exit strategy for the promoters, private equity investors and venture capitalists, since most of them will be waiting for an opportunity to dump the stock on gullible investors. Study the offer document to know how much stake is being offloaded through the public issue. If the percentage is very high, it is a red flag for investors.

Flavour of the month:

Avoid low-quality companies trying to ride the theme of the month.

Valuation is key:

Even a good quality company at a high price is a bad investment. Make sure that the stock is not priced higher than the other stocks in the sector. Compare the PE ratios of the company with those of its peers. The list of IPOs in the pipeline is very long, but experts think that only a few of these will prove to be worthwhile investments . “Except for the Bharti Infratel issue there is nothing much for retail investors,” says Prithvi Haldea.

Should you sell on listing?

Given the losses from IPOs, a lot of investors in the primary market book profits on the listing day itself . However, this is not a recommended strategy because the listing day price is very volatile and often manipulated. Even good IPOs can have a shaky start. Tribhovandas Bhimji Zaveri lost money on the listing day, but recovered later. If you had exited at a loss on the listing day, you would have missed out on the opportunity to earn 139% returns.

Even so, many investors swear by this method. Of the 59 IPOs in the past two years, 34 (or 58%) would have generated positive returns if you had sold them on the first day of trading (computed on a closing basis, because the first quote is mostly manipulated and it is almost impossible for anyone to get out at that price).

FPOs OFS

The follow-on public offerings are easier to evaluate because the stock is already listed in the market and the data is readily available for the past several years. The only thing to watch out here is the manner in which the company intends to use the proceeds. Is the money being raised to expand the business or just offload shares held by promoters?

As mentioned earlier, most of the FPOs and OFSs are not business decisions but have been forced by circumstances. The PSUs are coming out with public issues because the government needs the money to bridge the fiscal deficit. Some of the privatesector companies that need to bring their promoter stake to 75% are also coming out with FPOs. Though bad for the company, forced issues are good for the retail investors because they are a great investment opportunity. Those who had bought the shares of MNCs, which were forced to go public in 1977, will vouch for this because many of them have made fortunes from them.

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