Short supply doesn't mean great value

To take advantage of scarcity premium, apply in IPO

With the market going great guns, there are a large number of companies which are getting ready to list themselves through initial public offerings (IPOs). Many of them are big names, such as Reliance Nippon Asset Management Company, ICICI Lombard and HDFC Life, among others.

And there is something unique about all these stocks – either there are no or just one or two listed peers. In the absence of listed peers, these stocks are likely to command scarcity premium. The question: How much premium should a retail investor pay for a stock which has none or few listed peers?  “To assign a premium to a company, there has to be a proven track record in some aspect — it should have proven execution capabilities or a track record of corporate governance, etc. This should also be backed by fundamentals such as consistent return on equity,” says Jinesh Gopani, head of equity, Axis Mutual Fund.
 

The experience with companies commanding scarcity premium is mixed. When Justdial came up with its IPO in 2013, investors lapped up the shares. It was subscribed around 12 times. Its unique business model was one of the biggest reason for investors’ interest. Many, therefore, assigned a scarcity premium to it. The issue price was fixed at Rs 530 a share. The stock now trades Rs 416.25.

“Companies with unique business models or those which are the only ones listed in their sector get a scarcity premium. But if the profit growth doesn’t meet investors’ expectations, they start to lose interest in the stock,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory.
 

But there are many exceptional performers as well. For example, Infibeam, which has more than doubled itself from Rs 432 to Rs 998. ICICI Prudential and Thyrocare Technologies have also done quite well.

So what are the key parameters? Sunil Sharma, chief investment officer, Sanctum Wealth Management, says the company should have a sustainable business that can deliver growth. “We won’t assign a premium to a stock just because it’s the only listed company in its sector.” Even stellar past performance can be a good parameter. Sometimes, performance of global international peers can be used to take calls.

Gopani says if a company meets all the parameters, he decides to invest in it; he buys it from a three- to five-year perspective. If there are companies that don’t have even unlisted peers to compare with, investment managers look internationally to see if there are similar businesses that can be compared. For example: Stock exchanges.

The fact is that when markets are in a bull run, many recommend stocks by assigning scarcity premiums to justify their valuations. In the absence of listed peers, many investors rush to buy such stocks. The chances of losing money can be there as well.  So, this is tricky ground for retail investors. As a fund manager says: “Institutional players and high net worth individuals can play this game better.” For retail investors, the advice is simple: Apply in the IPO. If you get a few shares, well and good. But don’t enter the secondary market once the listing takes place just because the share price is going up consistently.