Should I subscribe to an IPO?

With the recent euphoria that has brought a lot of first – time investors to the stock markets – both in India and abroad, there has been a growing trend of another event.

IPO.

What’s IPO?

For the uninitiated, IPO stands for ‘Initial Public Offering’.

It is the first time when shares of an enterprise are offered to the public for subscription through the capital markets.

In recent times, a lot of companies have started offering Private assets too (unlisted shares of companies and startups) but more on that later.

The Company generally offers a portion of it’s shares for the public to acquire either through a ‘fresh issue’ or an ‘offer for sale’.

For a lot of companies, IPO is more about giving an exit to existing shareholders rather than creating value for new shareholders.

Allow me to explain.

In any IPO, there is huge information asymmetry.

There are folks who have been invested in a particular company for a really long time (including the promoters of the company). An IPO gives them an opportunity to value most of their investments at the true ‘market value’ instead of having to carry these investments either at cost or at a fair value.

Secondly, you will always find a lot of retail euphoria in the hope of listing gains.

This again circles back to the demand supply equation.

Normally, in any IPO there are specific slots reserved for each category of Investors.

Retail

Non – Institutional

Qualified Institutional Buyers

More often than not, you will find most of these categories oversubscribed.

Still doesn’t answer my question. Can you cut to the chase?

Before subscribing to any IPO, always make sure you go through the DRHP.

DRHP or the Draft Red Herring Prospectus is a goldmine of data and a wonderful document to give you insights about everything – the industry structure, the competitive intensity, the financials, the company’s history and ‘key risks’ of the business.

These documents can run into 500+ pages. It might sound over whelming but it is a great idea to spend at least 10-15 minutes skimming through it.

Where can I find the DRHP?

Do a simple Google search.

Company going to IPO + DRHP

The official SEBI site will direct you to the DRHP.

DRHP Done. What next?

First and foremost, subscribing to any IPO should not happen out of FOMO.

FOMO – Fear of Missing Out.

Either you should know what the Company is up to or be well abreast with their numbers or you should really spend some time going through the DRHP.

That’s all there is to evaluate before subscribing to an IPO.

But I know someone who does this for a living. He’s Rich!

Warren Buffet has often been quoted that he hasn’t bought into a single IPO since the last 54 years.

It was only recently his firm made a USD 800 mn gain in the Snowflake IPO.

With Real Interest Rates falling to historic lows all throughout the world, people are chasing alternate asset classes with higher expected returns.

This is a very popular graph that we are often told about since a very young age.

Higher the risk, higher the return. I had written extensively about this in a post here.

But if risky assets would always be relied upon for higher returns, they would not be risky in the first place, right?

In a time frame when taking on more risks always translates to better returns, undertaking this can be fruitful. It is only when things that are not in your control (unsystematic risk) go haywire, everything goes South!

This is the correct way to evaluate the Risk Return trade-off.

Higher the Risk, higher the range of returns. More often than not, the highest risk point may give you a higher expected return on the upside.

It may just give the same on the downside, which is often NEGATIVE.

Coming back to the question.

It may sound very appealing, the surplus money is lying in my account, let me apply for this IPO.

More often than not, the allotment might not come through because of the sheer over-subscription.

Only if the Retail part is not over-subscribed you have a sure shot chance of getting an allotment. Else, money stays blocked in Escrow (ASBA) for a limited time period.

Concluding Thoughts

There is no sure-shot game of getting listing gains on the day of listing of an IPO.

There was a recent company that had gone for an IPO in late 2019 and is currently almost 6x the IPO price. If you open the DRHP, it starts with 67 potential risks that the management themselves foresee!

(Can you guess the name of the Company? Do let me know in the comments section.)

If you plan to subscribe to an IPO, you should take some conscious effort to do some research around the company or at least be aware of their financials.

If you get comfort on the above two, go ahead and make your decision. This way you will have a basis of subscription rather than going by hearsay.

I am starting an annual access to the weekly webinars commencing 10th October, 2020. You can read more about it here.


While you’re at it, here’s a little mobile stand I got myself when the lockdown started to be on video calls, it has freed up my water bottle, pen stand, 4 book support and a host of other jugaad that took my space. Trust it helps you too.


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About the author

Saket Mehrotra

Number cruncher, avid reader, coffee connoisseur, book store hopper & Metallica fan. An active follower of Sensex since 2009. CA, CS by profession. The views expressed in this blog are my own and in no way represent the views of my employer.

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