The election results are out and the markets are rejoicing. The stock markets are in an upbeat mood. Sentiments have changed and the investors are excited about equities after a lull for over five years. When investors are excited about equities there are people waiting to cash in on that investor greed. We would now see a host of Initial Public Offerings (IPO) hitting the market. We have seen a bear market in the last five years and have not seen any IPOs. Lets understand the psychology of IPOs and the stupidity of investors to chase IPOs.
Why do we have IPO’s? Management wishes to raise capital from the markets for their ventures, offer stocks to the investors. Both parties benefit with the growth of the company and it is one of the cornerstones of capitalism. Win win situation for both the sides. This was true when the shares of greenfield projects were offered to the public at par or when the Controller of Capital Issues(CCI) controlled the pricing. In such situations people made money on their investments by holding the shares for a longer period of time. However today there is no CCI and the IPOs pricing is not controlled. Today they are priced at prices what the market can afford to pay. So we have a unique situation. The current situation is different but still the investors are anchored to the quick rich stories of the past IPOs.
How do IPOs evolve? There is an entrepreneur who has a business idea and sets up a company. The initial capital is provided by the angel investors and then comes the venture capitalist. The aim of both these initial investors is to exit from the company when they get a decent valuation for their stock. They are in it for the money they will make. So they wait for an opportune time when they can sell their stock through an IPO when the markets are upbeat and the investors have gone crazy willing to pay any price to own a stock.
An IPO offering is done through an investment banker. This investment banker is appointed by the company on a payment of a fee which is linked to the amount of premium that can be got from the investor. The investment manager makes a positive research report of the company, creates a hype and markets the same through its band of brokers. These investors make their decisions to invest in the company based on such research reports made by an agent of the company. Not a sensible thing to do.
Lets get back to the past. 1999/2001 we had the tech boom and saw a host of IPOs in that sector hitting the markets. Investors flocked to them and today 90% of them have vanished and those that have remained have made the investors poorer. Same was the case in 2005/2007 when we had the real estate, power and infrastructure boom. We saw a flurry of IPOs in that sector and investors who went for the bait have lost out. One notable example of the real estate boom was DLF IPO. Offered to the public at around Rs.600 (Rs.10 paid up) went up to Rs.1200 only to crash to Rs.150 when the real estate fancy ended. Another was the power sector craze IPO of Reliance Power called the mother of all issues. Offered at a phenomenal premium for a virtual greenfield power project ( Rs.10 paid up at Rs.430). Every investment banker sold the issue to the investors only to make them poorer on listing. These are just a few notable examples of the IPO losses for the investors. For more details on the IPO’s behavioural tendencies I have devoted a full chapter in my book “Value Investing and Behavioral Finance; Insights in to Indian Stock Market Realities”. I have compiled data on the Indian stock IPOs and the losses to the investors.
Now again after a lull of five years we are seeing the sentiments of the market improving. Managements would be preparing to cash in on the boom. As an investor you need to be smart and not fall for the bait.Why do IPOs not come in Bear Markets? Because during bear markets investors behave rationally and are not willing to pay any price to own a stock. Fear is dominating. However in Bull Markets Greed dominates, investors become irrational and are willing to pay fancy prices. In such a situation management would like to sell their stake to the public as they are getting more than the intrinsic value. Keep your emotions under control and don't get carried away by the IPO boom which will surely hit the markets in the current future. The IPOs expected to hit the markets would be in Infrastructure, Power, Capital Goods and Real Estate as these are the fancy sectors. During bullish times IPOs are not in your financial interest. If you like a particular IPO wait for the euphoria to get over and within a year when the cold period starts you can invest. I am equally bullish on the Indian Stock Markets but that does not mean that you buy anything, especially that which is thrown at you by the management.
