4 Point Checklist to Invest in Crorepati IPOs

Editor's note: Zomato's IPO is the talk of the town right now but there will be many more that hitting the market soon. How should you go about investing in these big ticket IPOs? Here is a handy editorial written by Tanushree to guide you. Read on...

---

Zhong Shanshan is not an ordinary billionaire. The chairman of Chinese bottled-water company Nongfu Spring, he recently trumped Warren Buffett, Larry Page, and Steve Ballmer to become the sixth wealthiest person on earth.

Zhong's schooling was interrupted during China's cultural revolution. He later worked in construction, as a reporter, and later in the bottled-water business.

His net worth stood at US$ 17 bn after his drug company listed in April 2020 and multiplied 26-times in less than a year.

Known as Lone Wolf by the Chinese media, Zhong's story is ripe for a Bollywood blockbuster.

But back in China he has 24 other billionaires competing with him, chasing IPO riches. Crorepati IPOs became commonplace in China in 2020 in the midst of the pandemic.

And the crorepatis include promoters who were formerly teachers or accountants or software engineers.

The coronavirus pandemic shut down large parts of the economy and slowed growth.

But buoyed by an army of retail investors looking for quick returns, the Chinese IPOs created a bunch of billionaires and scores of millionaires.

The reason I am writing about this is because I see several crorepati IPOs in India over the next few years...starting 2021.

Everyone has heard and read about the upcoming LIC IPO.

The insurer still has over 70% share of all life insurance policies sold in the country.

And its assets under management stood at Rs 31 trillion in 2020. These facts alone make the IPO very enticing apart from its potential size.

Add to that the government's plan to privatise some PSUs to raise funds for infrastructure spends.

The success of PSU IPOs like IRCTC makes this disinvestment plan a hook for IPO gains in 2021.

But IPOs certainly aren't always a win-win.

And my team has been reminding readers of the risks for years.

Back in 2008, Economic Times called out Equitymaster for being the only entity with an Avoid view on Reliance Power IPO.

As value investors, we have taken comfort in the fact that a legend like Buffett passed on the opportunity to subscribe to Google's IPO in 2004, which was offered at over 52 times earnings.

In addition to Buffett's general reluctance towards the business models of most internet companies, Google's early valuations clearly didn't interest him.The stock returned nearly 1400% in ten years, proving Buffett's intrinsic value calculations wrong.

But he didn't compromise on his margin of safety criteria.

And the legendry investor never regretted his decision.In India, investors who skipped the initial offerings of stocks like Infosys, TCS, HDFC Bank, eClerx, Page Industries, etc over the past two decades may have regrets.

But most did not pass on the IPOs over valuation concerns. More likely, they were ignorant of the potential of these soon-to-be bluechips.

Or they underestimated the companies' moat and growth prospects.But the fact is that, like Google, each of these companies have offered post IPO investors plenty of opportunities to join their wealth creating journey.

It was an opportunity to become millionaires.Buffett has explained that the mathematical probability of fetching a good stock at cheap valuations in its IPO is minimal.

Therefore, investors hoping to become IPO crorepatis have to rely on luck apart from their value investing skills.To better your chances of becoming IPO crorepati in 2021, try following a checklist.

So that even if it is not valuations that you wish to worry about, companies with flawed fundamentals should not land up in your IPO list...

1. Companies in regulated sectors such as telecom or fintech face very little bottlenecks in the first few years of operation. But as the years go by, the regulatory supervision increases. Therefore, you need to be wary of the possibility of regulatory bottlenecks suppressing growth and margins in the long term.
2. Companies with extraordinary growth or profitability need to be evaluated on sustainability. If the profits are not coming from sustainable client or vendor relations, you can avoid them.
3. It is not until the stock gets listed that you know that extent of transparency in its financial dealings. You can't judge the management's willingness to proactively explain challenges. Therefore, you would rather not buy a stock that would not have a business as simple as selling toothpaste.
4. Since most companies do not have a clear dividend policy prior to listing, all healthy cash flow generating entities may not have the best payouts. So, while it is good to buy a cash-rich listed company, betting on rich dividends at the time of time of IPO may not work in your favour.

Warm regards,

Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)