How to choose the right IPO

"Thank goodness IPOs are back! Now I can easily double my money in no time...," writes a 25-year-old stock trader on his blog.

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Special: Initial Public Offerings

Well, had it been 2006 or even 2007, this young blogger's confidence would have found many takers. But with only six offers so far, the sentiment this year is still a far cry from the IPO euphoria that had defined the investment contours of the previous two years.

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Companies of all sizes, sectors and even promoter background - the good, the bad and even the rare ugly ones - had realised their IPO dreams then, while investors reaped generous rewards from almost every investment.

Regaining lost ground

When pitted against this, the present year does fade in comparison. But it may not remain so for long. Going by the build-up in the IPO pipeline, the year may still go on to become one, which sees the return of IPOs. Pepped up by the successful completion of offers by Mahindra Holidays & Resorts and more recently Adani Power, promoters of many companies have filed IPO applications with the market regulator.

So, while the stage is set for IPOs to make a comeback, given the market conditions and the deluge of offers, choosing one over the other may not be easy. Here's a look at the factors that should be considered while buying into an IPO.

Old wine or new bottle...

More often that not, companies that line up for IPOs have many peers in the listed space. And that should form your first level of filtering. If the company that has come up with an offer enjoys a better infrastructure, technology or market share or offers better growth prospects over its listed peers, the choice is easy. You may be better off investing in the new offer that promises a superior growth trajectory.

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Alternatively, IPO investing can also be considered when the company has no listed peers and operates in a niche business segment.

For instance, OnMobile Global, which provides telecom value-added services, despite having timed its offer badly - just after the January 2008 crash - would have made a wise investment decision given that it had no peers in the listed universe. Ditto for the toll road operating company IRB Infrastructure, which tapped the primary market around the same time.

But at what cost...

But what if the new kid on the block has nothing new to offer or is another me-too player in an old sector? In such a case, what can help you decide is the pricing of the offer. Find out if the offer is priced at a discount, at par or at a premium to its peers. If at a discount, find out why. Is it because the company's prospects are that much less bright that its peers' prospects? If at par or at premium, find out if the business offers something unique that justifies the IPO pricing. Answers to these questions would help you assess the offer.

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Remember, the lure of investing in an IPO should be the pricing bargains that you can get vis-A-vis investing in the same company after listing. Therefore, if you feel the offer is stiffly priced, don't hesitate to give it a wide berth. Not investing in an IPO only means that you can't buy into it at the offer price, at that time. You can always take exposure to the stock post its listing, and if you are lucky at a much better price too.

For instance, but for a handful, a good majority of the public offers made during the previous bull run traded below their issue price last year. Even companies such as Mundra Port and SEZ, which offers a niche play and whose offer had seen high subscriptions and even higher gains on listing, fell below its offer price in 2008 following the broad market corrections.

Allotment, subscription...

More often than not, most investors tend to base their decisions on the subscription figures received by the offers. But a huge over-subscription shouldn't really make you reach for your cheque book.

If you are a long-term investor and looking to grow your wealth by investing in IPOs, know that subscription numbers, at best, can only help gauge the probability of allotment of the shares. Responses to IPOs are often just a function of the market conditions at the time of the offer.

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It isn't any indicator of the prospects of the company, as it sometimes may be made out to be. Who can forget the record subscription (more than 70 times) raked in by Reliance Power IPO in early January 2008? That didn't prevent the stock from tanking to less than half the offer price, in the months after listing.

On the contrary, the issue of wagon manufacturer Titagarh Wagons, which just about managed to get fully subscribed in the retail category, managed a better performance on listing.

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Even in the case of OnMobile Global and IRB Infrastructure, though both the companies scored high on business fundamentals they were accorded only a lukewarm market response given the timing of their offers. So, while a good IPO may flounder in a declining market, a fly-by-night company may easily rake in the money if the market sentiments are upbeat.

As a long-term investor, you would need to evaluate an IPO not by subscription figures and grey market premiums but based on whether you would like to buy into the business for which funds are being raised.

As Benjamin Graham, the father of value investing puts it: "In the short run the market is a voting machine. But in the long run it's a weighing machine."

Special: Initial Public Offerings

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