Why retail investors must avoid almost all IPOs

Last week, amid the cheerleading of the Zomato IPO, a small minority of commentators pointed out the advanced state of undress the emperor was in. However, the general talk was that there was some kind of euphoria about this IPO. In the Zomato IPO as well as the IPOs of similar outfits that will no doubt follow, this talk of euphoria will no doubt be at a fever pitch. To explain the reason, I’ll narrate an old lawyer joke.A famous professor of law was lecturing on courtroom strategy. “If you have facts on your side, hammer on the facts. If you have the law on your side, hammer on the law.”“But if you do not have the facts or the law,” asked a student, “what do you do?” “In that case,” replied the professor, “hammer on the table.”The cheerleading and euphoria that you will keep hearing in the IPOs of these kinds of companies is the hammering on the table. When there’s no track record or profitability to speak of, when there’s no precise plan on what the collected money will be used for, then one has to necessarily talk of just the euphoria and the ‘hotness’ of the stock.However, this is not to say that these are the only reasons that individual investors like you should have avoided the Zomato IPO. You should avoid almost all IPOs, regardless of the quality of the stock. That sounds like a radical view but it’s actually quite logical. First of all, while investing in any stock, the reasons should all be based on the track record of the company and its prospects. Whether a stock is an IPO or not does not matter at all as far as this evaluation goes. However, there are other reasons why IPOs are avoidable. The basic problem in IPOs is that, unlike secondary market investing, there’s a huge information asymmetry between the seller and the buyer. In India, we have long entertained this idea that IPOs are somehow especially suited for retail investors. In the days of the Controller of Capital Issues and administered price IPOs, that may well have been true, but not anymore. Market regulator Sebi, as well as other bodies, have frequently tried to encourage the small investors’ interest in IPOs. Parts of the IPO process have also been tailored to suit this purpose.However, retail investors should studiously ignore them. There is nothing about IPOs that makes them especially suited for the casual retail investor. If anything, compared to listed stocks, IPOs are actually less suitable for such investors. The reason is simple. IPO companies are not understood well. The balance of power (in the sense of information being power) lies with the seller. The companies have not been in the public eye at all. Invariably, the promoter has spent the preceding months carefully building up an image to ensure that the investing public has a positive image. Unlike listed stocks, the financials haven’t been scrutinised closely for years and years. And of course, the price is the promoter’s gambit, rather than one that has been found out by the price discovery mechanism of the markets.The lottery days are long gone. Now, even the best-performing IPO stocks have periods where they are available below the issue price at some point. This is the inevitable result of IPOs being priced as aggressively as possible. If a company is good, you’ll get another chance, and if it is not then let that be discovered at other people’s cost. Institutional investors may be under pressure to not miss out on anything but for individuals like you or me, equity investing is not like batting in the last over of a T20 where you must hit everything. Rather, it’s like building a long innings in a test match where you can always let a doubtful ball through to the keeper and hit only the ones that are certain boundaries.(The author is CEO, Value Research)

from Economic Times https://ift.tt/3zzv7aN