Beware, the IPO boom is here...

Tue, 27 May Pre-Open

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Exciting times are here again. Especially with the Indian stock markets! They stand in ultra bullish mode, thanks to the new government in power. The euphoria has brought about a positive investor sentiment into equities after a lull for over five years. But there's something more to be excited about. Upbeat markets open gates for IPOs. Bullish markets and IPOs generally band together. So gear up to be bombarded with a flurry of IPOs that are soon to hit the bull markets!

But should we buy stocks in an IPO? Well, before we find answers to that, let's take a glimpse at the past. Remember 2007? The infrastructure and real estate boom had swept the markets. And then came the mammoth DLF IPO. Priced at Rs 600 for the public, the stock went on to higher levels of Rs 1200. Only to come down later to paltry Rs 150! If that craze wasn't sufficient, then we had another. The giant power IPO of Reliance Power wooed the investors. The mother of all issues was up for offering at a price of Rs 430. And later ended up making the investors poorer!

So if we haven't learnt the harsh lessons yet, we still have time. For sooner history is all set to repeat. And this time we should not fall for the bait. How? Let's get to the basics for knowing the nuances of an IPO in the first place.

What is an IPO? It is the first sale of stock by a private company to the public. Small companies often seek capital to expand. At times even large privately owned companies look to become publicly traded. So such companies wait for the appropriate time. And when the markets are favorable, they sell their stock through an IPO. An IPO offering is done through an investment banker. Appointed by the company, the investment banker charges fees for its efforts to reach out to the investors. This exercise is generally routed through a band of brokers who prepare positive research reports of the company to entice investors to invest. Is it appropriate then to get carried away by such reports and invest blindly? Certainly not!

Most of the times IPOs end up making the company management richer and the investors poorer! The instances of DLF, Reliance Power and the likes are a case in point. Also did you ever realize this? That IPOs spring up only in the bull markets! That's because the company management prefers to take advantage of the boom and raise money by luring investors. None of the companies have come up with their IPOs during the bear markets. Because in a bear market, fear dominates! Whereas in bull markets, greed prevails! And this greed paves way for irrational exuberance. In such times, investors fall for the irrational optimism and are ready to pay fancy prices even for cheap stocks. And this becomes the opportune time for the company managements to woo investors to buy the stocks. Remember what Buffett said. "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

Therefore, as a rational investor, we should not get carried away by the IPO boom.

Investing is a thought-out, long-term exercise. Short-term gyrations and IPO lures will only lead investors to meet up with disasters. Lastly, we leave you with a food for thought again from the legendary Buffett! "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."

Do you think that this is time to be greedy or fearful in the markets? Do share your views on Equitymaster Club.