Investing in IPO – Pros and Cons

The sequence is unmistakable. First, there would be a prolonged bull run in the secondary market. Next is the turn of the primary market to follow the action. It happens always, and it is no different this time. Look up the number of initial public offers or IPO (the first public issue of shares by a company) lined up in the recent past. Read some of the names and they do not sound impressive. Well that is the whole point to be cautious about an IPO.

Many dubious companies are in the process (some already have) to crash in on the investors fancy for stocks, following a continuous bull run in the market for the last four years. There is nothing new in the trend. Every time you see the market booming you will also notice that a lot of companies are readying up their public offers. In fact, they have been waiting for the right time. The sad part is along with genuine companies, a lot of dubious characters also get into the market. They know they can cash in the favorable sentiment in the market.

That says it all. Sure, we have glorious example of Reliance, who raised money from the stock market to build companies of Ambani’s (senior) dream. However, there are hundreds of dubious characters who also sold dreams and raised money from the market, only to vanish overnight with investors’ hard earned money. When the market is booming, everyone wants a piece of the pie. It is difficult to get allotment in good IPOs in a booming market. Disappointed investors would then turn to dubious issues, thinking they can make quick bucks. When the tide turns, they end up with dud shares.

The intention is not to dissuade investors from subscribing to IPOs or forcing them to look at every IPO suspiciously. It is to make them aware that the rule of the game is not different for IPOs. It is the same as one buys any stock. An investor has to do his own research if he wants to make money. Don’t think every IPO would fetch profit on the day of listing at the stock exchange. Be it the secondary market or primary market, an investor should always remember that he can make money only on quality stocks. For that he has to look at the track record of the company, its management, the industry etc.

That is exactly the problem. Stocks which are already listed in the market will have a lot of financial data and research available in the public domain. However, when it comes to IPO, one has to rely solely on the prospectus which makes the research little tedious. However, if the investor persists he will get most of the crucial data like the history of the company, details about the management, and financial data among other things. Sure the investor may have little apprehension about the reliability but still he can make a good analysis.

An investor must stick to known names in an industry he is familiar with. He must also, find out from the media what kind of interest the issue is generating among institutional or prominent investors. Place extra attention to industry you are getting into. When the market is on a song, all sectors may be performing well. But most industries have a cycle and it may catch up sooner or later.

Pricing is another key area. IPOs are mostly highly or overpriced in a booming market. This could become a serious disadvantage when the tide turns. Look at the kind of valuations some of the IPOs are getting these days. Obscure companies are commanding the same valuations as their peers in the business for a long term. That is not realistic. When there is down turn, lesser known companies would be hit harder. Known names would withstand the trouble and bounce back. It will not be the same for the new companies.