April 15, 2007

Why I avoid IPO’s

I have a very irrational reason (yes it is not a typo) for not investing in IPOs. My thinking is like this (A hypothetical tale)

I have a house and wish to sell it. Also I have a decent cash balance and I am no hurry to sell the house. I will sell the house if I can get a good price for it. Looking around I realise that my neighbour has just sold his house at a fantastic price. That tempts me into start looking for buyers and I approach a few brokers to test the market. The brokers are extremely bullish and tell me that this is a good time to sell and the market is hot !. I get all excited and invite a few brokers to come over and look at the house. A few brokers come over and have a look at the house. On inspecting the house, they notice a few problems in the house. The west side wall seems to be weak and roof needs repairing. They ask me to repair the roof and paint the walls so that the these ‘defects’ can be hidden. I go ahead and start the repairs and meanwhile the brokers are looking for buyers.

The broker meets the buyers and tells them that they have a great house on the market. The price for houses in that area have increased by 50% in the recent past and this house is a great deal. The buyer, all excited by the likely appreciation, comes over, looks at the house and agrees to buy it. A somewhat weak roof and wall goes un-noticed because the house is a great ‘investment’. Why bother checking!!

So the deal gets done and everyone is happy. I get a good price, the broker his commission and buyer gets the dream of price appreciation and hopes of profits in the future.

One year later, the RBI in all its wisdom raises the interest rates. The housing market starts slowing. Buyers are now more discerning. They are not buying to invest, but to stay. A house with a weak roof and wall is not a good place to stay. The buyer is finding it difficult to sell the house and has EMI to pay on top of that. Dejectedly he sells the house at a loss and resolves never to get sucked into such a scheme.

Ok, I am not an evil scheming guy :)

So now replace me with company, broker with merchant banker, buyer with investor and house with a company and you would get the point.

If I have only X no. of hours in a week to analyse stocks, why waste time looking for needles in an IPO haystack when I can find them more easily in the rest of the market (with full knowledge of all the problems and leaky roof !!)

10 comments:

Prem Sagar said...

Hi Rohit,
I can add 2 more reasons to your reasoning.

The better the stock is, the worse is your chance of allotment!

If your networth is high, retail category hardly gives you any significant allotment. If you apply as HNI, the subscription multiples are so high that you are better off staying away than locking lot of cash to receive a paltry allotment.

By the way, I have benefitted a bit in IPOs. IDFC, Yes bank, ICRA, Mindtree, AIA engg, Educomp, Everest kanto, Suzlon, Bartronics, etc...I have had a good IPO stint.

Except IDFC and Yesbank where I bought more after listing, I have sold almost every ipo on first day.

But I gleefully acknowledge the market hand in IPO listing prices and not my 'intelligence', though I have done well in avoiding ordinary/poor IPOs.

I 'play' (as against invest) for taking advantage of first day euphoria pricing in 90% of the cases. It has worked for me!

Prem Sagar said...

And wanted to tell you this!

I was going through my 2006 diary, Feb month.

I had written that I was impressed by your blog and would start one myself.

So my inspiration for blogging started by reading this blog!

Thx a ton!

Rohit Chauhan said...

In addition, IPO's are more prone to market psychology. most are launched during bull market and the good performance comes from the bull market and general optimisim towards IPO than anything else
also when the cycle turns, new IPO's turn to a trickle. Also IPO's during later part of the cycle are generally of poor businesses and priced high
finally IPO investing in my view involves trading, figuring out the short term trend of the market and a lot of times speculation. I am not good at any of those

Rohit Chauhan said...

hi prem
good to know that this blog contributed to your decision to start blogging. i guess it has turned out to be a enjoyable and good experience for you

rohit

Niraj said...

Rohit,
Your reasoning sounds pretty rational to me :)

Window dressing forms a significant portion of I-Banking activity right before listing, distracting the investor from underlying risks and concerns. Or more recently each Red Herring contains a laundry list of risks in legal language putting so many disclaimers in place that its all an eyewash for the ordinary investor. Eitherways intrinsic value becomes hard to discern.

Nil said...

Rohit,

Can you please let me know your view on "Kewal kiran clothing limited". i bought cloths from one of its brand easies from bangalore central. that is how i noticed this .

# its a textile/retail play
# PE of approx 13 - much lower than valuations for companies in the same segment (pantaloon retail 85, raymond 15, provouge 49)
# brands - killer, lawman, integriti, easies - 50% share of killer and only popular brand from company
# has its own ~40 k-lounge stores. but its brand are not prominently displayed in stores such as central/shoppers stop.
# concern to me - its top 5 executive are commanding annual salary of Rs 12 million between them with net profit for company last year at only 110 million. so this salary seems too high to me.

Ketan said...

good blog... and good post...

http://greenbuck.blogspot.com/

Shiva said...

Rohitji,

Good post but... where is the SEBI role Draft RHP has to submit with SEBI and it have to get approved.

If IPO market is not there... we can't think of secondary market

Atul Mishra said...

Well, nothing personal but looks like a weak analogy. While I too am a disbeliever of distributing sureshot growth for equity. However in your example house cannot be a company. A house in same area will have a similar price like its neighbours, unlike a company PE in same industry. House isnt a growing asset by intrinsic factors unlike a company which is. Possibly you assumed the house was sold at peak like its easy to know what future holds :). And everything went wrong afterwords just to prove upon a logic. But I agree with your starting statement ;)

Rohit Chauhan said...

its an analogy my friend !! and have you heard of any company coming out with an underpriced ipo ? who wants to sell something for less than what its worth ?

we are not talking of buying a company based on known factors. we are buying a company in an IPO based on financials which have been scrubbed to look the best.