NRVER BUY IPO
All of us love quick money. We feel very good if we bought into an IPO and it lists at a premium. We bask in the glory of our achievement. There is a psychological high in having made a smart investment choice. But is investing in an IPO the best way to grow our wealth? There are four reasons why it is not.
First, the company making the IPO places detailed information in public domain and advertises itself extensively. If you are hearing the name of a company for the first time through ads and hoardings all over town, you know it has filed for an IPO.
You run the risk of buying the stock amidst an artificial buzz for the company. It would take a good reading of the prospectus to get an idea about the business, the management, the risks and the returns. Despite the availability of information, there is limited quality analysis available to investors when the issuer is focused on ‘marketing’. Amidst several recommendations to buy or ignore the IPO, investors run the risk of biased analysis and herding.
Second, the pricing of an IPO is a puzzle. If it is priced cheap, the issuer places money on the table for the investor to pick up. Common sense tells us that they are unlikely to do this, unless desperate for subscription. If such IPOs list at a premium—as they are bound to due to cheap pricing—the subsequent IPOs are gradually priced higher.
Investors begin to believe that all IPOs will list at a premium, and eagerly buy newer IPOs at higher prices. As more IPOs list at a premium, the pricing gets more ambitious, thus reducing the chances of a premium listing. A cheap IPO is thus a phenomenon that will correct itself, sooner than later and investors may end up holding an expensive IPO when the cycle ends at the height of investor frenzy.
Third, the amount invested in an IPO may not be significant. The more popular and over-subscribed an IPO, the lower the allotment to investors. Therefore, an investor has small amounts invested in several IPOs. Even if some of them turn out to be multi-baggers, the impact on the investors’ overall wealth would be limited. Unless there is a significant accumulation of a winning stock, three-digit gains may not make a difference.
If you had invested `10,000 in the HDFC Bank IPO at Rs 35 several years ago, you have a tidy profit, but how much of your current wealth is in that stock? Habitual IPO investors typically end up with several stocks of mixed quality. Wealth creation needs greater focus.
Fourth, the lure of listing profits can lead many to borrow to invest , or participate in sharp practices. Many lend their demat accounts for a fee, indulge in grey market trading before listing, and file multiple applications. These come with the thrills of speculation and the risks of leverage. To large and wealthy investors, these are games. Small investors with limited wealth may also behave callously with their money.
Instead of aligning investment habits to their abilities and wealth, they may take undue risks. IPOs can trap even the sanest to taste quick gains.
Should IPOs have a place in the portfolio of an investor? Yes, they should, but only as a smaller portion, not as a core strategy to build wealth. A small amount can be churned around in IPOs, while the core portfolio is held for the long term. Many of us buy an IPO with the intent to sell at a profit on listing. When it lists low or sinks after listing, we quickly convert it into a ‘long-term’ buy. This is one IPO habit to be shunned at all costs, since it is the surest way to hold junk in the portfolio.
Zerodha (Trading Account)
RHP
