There is a big debate on the recently concluded NMDC follow-on public offer (FPO). It is one of the biggest disinvestment offers, as it seeks to fill the government coffers by raising up to Rs 20,000 crore.
I got a call from a friend who was asked by his broker to sella few existing shares and apply for NMDC’s. There are adventurous ones who even borrow to invest in initial public offers (IPOs). High networth individuals (HNIs) are invariably pitched to invest in such public offers with borrowed funds and to exit on listing. The borrowing often happens at the rate of 16 per cent and the investor makes a quick buck if the listing is great. However, many investors have burnt their fingers with such public offers, earlier. One of the biggest example is the Reliance Power IPO, where investors, who were positive about the power story, were powered off when the stock tanked on listing.
Since history is never remembered till it repeats itself, I am not so sure if investors still remember that episode. In fact, most of the power, real estate and other IPOs that made their debut two to three years back are still way below their offer price.
In fact, most real estate and power IPOs (not to forget those during the dotcom era) during in the boom time have always lost the investors’ money. When I had told a group of investors in 2007-08 that power stocks were overvalued and were behaving like technology stocks of the dotcom era, they looked at me as if I was a fool. I was confronted by various theories such as power shortage in the country, capacity build-up and land banks for real estate companies. No one seemed to bother about earnings growth, cash flow, return on equity, etc.
That was the era when housewives, paanwalas and everyone possible had become fund managers overnight. Though several IPOs scraped through, they suffered miserably in the 2008 downturn.
This is because most IPOs were overpriced. Additionally, if an IPO is good, there is a very small allotment made to individual investors. Even some of the mediocre IPOs manage to get a stellar response from retail investors, as they were aggressively sold. Should you, then, sell your existing shares or borrow to invest fresh money in the public offers?
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The cardinal rule for most investors is to never borrow and invest, whether for an IPO or in stocks. If you have a huge portfolio of stocks and some have run up significantly in a short period of time, you might consider selling a small portion of a stock for subscribing to an IPO which has attractive valuations and growth prospects. But, remember, the chances of allotment of an over-subscribed issue are remote and any allotment would be negligible.
It's rightly said that IPOs stand for 'It's Probably Overpriced'. I would, in fact, go further and say these IPOs offered by a coterie of promoters and investment bankers are nothing but Idiotically, Presumptuously and Obscenely priced offerings, aimed at raising easy money. Therefore, it always helps to go back to basics, like the one stated in the book, The Intelligent Investor. Benjamin Graham cautioned investors that, "No matter how many people want to buy a stock, you should buy only if the stock is a cheap way to own a desirable business. At the peak price on day one, investors were valuing VA Linux at a total of $12.7 billion. What was the company's worth? Less than five years old, VA Linux had only sold $44 million of its software and services -- but had lost $25 million in the process.
This business was losing 70 cents on every dollar it took in. If VA Linux were a private company owned by the guy who lives next door and he leaned over your picket pence and asked you how much you would pay to take his struggling business off his hands, would you answer $12.7 billion? But, when we are in public instead of in private, when valuation suddenly becomes a popularity contest, the price of a stock seems more important than the value of the business it represents. By December 9, 2002, three years to the day the stock was at $239.50, VA Linux closed at $1.19 per share."
Check the answers to some very simple questions before you subscribe to an IPO:
# What does this company do and is there a demand for its products and services? Will the demand continue to grow?
# What are the profits made by this company in the past two years and what is the projected profit growth for the next two years?
# Is the business generating cash flow from operations? What is the book value per share of the company?
The writer is director, My Financial Advisor
