Myths About Investing in an IPO
The beauty of IPOs is that, like any other investment avenue, it has its own share of myths and fables surrounding it. One of the popular beliefs is that an initial public offering or IPO is a ticket to quick profits, which is not necessarily the case. There are other popular myths like the IPO share price will always list above the issue price i.e. at a premium. Maybe we just need to show them Paytm chart post listing. These are just a couple of myths pertaining to IPO investment and none of these ideas are backed by reality. However, myths are not born out of a vacuum. They have a basis in a view point that is perpetuated by brokers and media persons and partially experienced by the investors.
It is true that the IPO process or should we say the allotment process, is favourable to retail investors. This is true for all types of IPO in the market including fresh issues, offer for sale and follow-on public offers. Why are we talking about IPO myths at this juncture? Remember, when you formulate your IPO investment strategy, it is very important that you go through these myth busters. Some of these myths may appear to be very inane and some appear to be obvious. It is not about the myths. It is about knowing the real truth behind these popular myths and fallacies.
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Five very common myths that investors carry about IPOs
Actually, if you sit down to list the myths, you would get tens of them. However, for the sale of simplicity, we have distilled these into just five critical myths that can have a bearing on your IPO investment decision.
- The first and perhaps a very popular and rampant myths is that you can just invest in any IPO at random and you will make profits. How we wish that was true but that is not the case. In good times more IPOs have done well and in bad times more IPOs have done badly. Then there are sectoral depressants like the digital IPO story in India in 2021. Almost all the big digital names that came out with an IPO have destroyed wealth for the Indian investors. For instance, Paytm came out with an IPO at Rs2,150 and is currently quoting at a stock price of less than Rs600. That is a lot of capital depletion. This is true of so many other digital IPOs too like Policybazaar, CarTrade, Zomato, Nykaa and Delhivery. These were all mega IPOs with large retail and institutional participation. Closer home another example of wealth destruction is of insurance companies, especially the PSU insurance names. For instance, GIC and New India Assurance led to huge losses post the IPO in 2018. Much more recently, the LIC IPO has also destroyed a lot of investor wealth, with the stock still more than 25% lower than the IPO price. To cut a long story short, there is no generic rule that IPOs will automatically generally profits.
- The other myth is that any company that goes public is also a very cash rich company. In fact, it is the other way round. For instance, a company decides to go public because it needs funds for carrying out its business activities. These funds may be required for expansion, repayment of debt, inorganic growth or even for working capital needs. The truth is that most companies approach the IPO market when they need funds and not when they have surplus funds in the books. In last two years, majority of the companies have raised funds to repay debt and reduce leverage. Perhaps, companies doing an OFS are better off financially, but companies to the new equity fund raising market only when they need funds to work their plans.
- The third popular myth about an IPO that investing in any IPO makes one an early investor in the company. That is far from the truth. It is true that many of these IPOs are by entrepreneurial companies so there is a bet on new business. But look at some instances like TCS, which came to the public issues market nearly 30 years after it was formed. Same is the case with Wipro and Godrej, which had remained as a privately held company for a long time. You can also take the case of digital companies. Many of them have been around for a long time and some have done several rounds of funding from global PE funds and VC investors. Normally, early investors in any company are the promoters, the promoter group and the early stage seed funders. That is why, they would end up taking bulk of the growth returns on the stock and bulk of the early returns. With the rise of PE funds and VC funds, most promoters prefer to realize valuations as closer to target market cap before going public.
- This looks like a great IPO as it has well known anchor investors. Don’t we often say that because we like to see big names like Government of Singapore, MAS, Fidelity and Nomura as anchor. But, how do we interpret anchor investors. Remember that anchor investors are not long term investors, as many would like to believe. Anchors invest just a day ahead of the IPO opening and at the same IPO price that will be made available to the general public. The whole idea of an anchor investment is to give confidence to the small investors about the quality of the IPO. Formerly, anchor investors had a lock-in of just 1 month, but post April 2022, lock-in applicable to anchor investors is 1 month for 50% of the investment and 3 months for the balance 50%. However, 3 months is still a very short period to call them long term investors. The experience in the past has been that anchors look at the first available opportunity to exit the IPO counter so they can churn their funds effectively.
- Finally, there is a myth that higher the risk in the IPO, higher would be the returns. Like in other parts of the market, the causality does not always work that way. For instance, higher returns entail higher risk. However, just because you take higher risk, it does not mean that you automatically earn higher returns. For instance, IPOs like Paytm or CarTrade or Policybazaar were high on risk but gave negative returns. On the contrary, the IPO of Adani Wilmar was lower on risk but gave bumper returns post listing. Then there have been several PSU IPOs that have been low on risk but have also given very tepid returns. Just taking a higher risk is not a guarantee of higher returns. In IPO investing, you must be a sharp shooter than shooting from the hip.