Is it Good to Subscribe to the Upcoming IPO?

Investor Subscribing to IPO Online Platform of Stock Exchange

Recently a professional colleague asked me if it is good to subscribe to a certain upcoming IPO. He mentioned that he always keeps a close tab on the IPO calendar as IPO stocks have always fetched him handsome returns, and he eagerly looks forward to new IPOs.

My answer is an emphatic NO!

People may argue that many good issues have yielded handsome returns or gains on listing – meaning the shares traded on the stock exchange at a price over and above the IPO offer price. 

Listing Gain should not be the Reason for Investing

I don’t deny that it is possible for a particular issue to trade at a higher price, for a short time.  But again it is fundamental difference in approach between a trader and value investor.  The question is not about price.  It is about value.  The question is whether the share being offered for subscription is at or near its fair or intrinsic value?  What price to earnings (PE) multiple is it sold? Is it ten times or near about ten times the earnings per share (EPS)?  The answer invariably is a no.  

Mostly IPO Stocks are offered at not less than a PE of 20 and some times it may go as high as 40 times the earnings.  In simple language, a PE of 20 means it will take 20 years for the company to earn the investment back for the investor, and a multiple of 40 means forty years.  To complicate the matter further, PE and EPS refer only to earnings by the company and not by the investor.  

Considering that companies hardly distribute more than 25% of their earnings to shareholders as dividends, it will take four times more number of years for the investors to recover their own investment!  Whereas the simple fixed deposit with a bank will recover the investment in 10 years, in India, assuming an interest rate of 10% per annum.  Of course, we have considered only the earnings and dividends in this analysis and not price increase either on the back of growth in earnings or otherwise.

One can Buy IPO stock Much Cheaper on the Stock Market

Even if we go by traded price on the exchanges, history shows that in the medium to long term, mostly IPO shares loose their value significantly.  One could easily buy the same shares at less than half their issue price if not more, in a few years. 

Value – that is any potential for future price growth - is almost fully extracted by the IPO company and investors are left high and dry either with losses or minimal gains. Ironically, it is not different even in the case of government owned or public sector companies.  This sorry state of affairs may be attributable more to the merchant bankers and advisors to the issue rather than the companies or their promoters or managers.

In the Coal India IPO of the year 2010, the price was fixed at Rs.245 a share.  It was billed as India’s largest IPO.  The company raised over Rs.15,000/- crores ( Rs.150 billion). The issue was over subscribed by 15.28 times. 

For the financial year ended on 31^st March 2010, the company had declared earnings per (EPS) share of Rs.5.97 and book value of the share was Rs.14.67. 

It means that the shares were issued at a PE multiple of 41.03 times (245÷5.97) and a price to book multiple of 16.70 times.  Whereas, the prescribed limits in value investing, are just 10 times PE multiple and 1.5 times the book value.  This mean the fair value of the share in the IPO was not more than Rs.60.

Today (Friday, 6^th May 2016) the closing price of Coal India share was Rs.281.95.  The share is trading at a PE multiple of 14.81 times and a price to book value multiple of 4.41.  Assuming that the EPS has remained constant 1t Rs.5.97, applying this PE multiple you could have bought the same share in the open market at Rs.88.41.

Conclusion

In the light of the above discussion with example it becomes amply clear that my friend's contention of watching the IPO calendar as IPO stocks have always fetched him handsome returns, and he eagerly looks forward to new IPOs, does not hold good, The answer to the question, "Is it Good to Subscribe to the Upcoming IPO?" is a definite no.

Which is Good - Predicting or Reacting to the Stock Markets?

Speculator gazing the market to predict market behaviour

Day in and day out, print and television media are agog with stock market forecasts and stock predictions by  so called experts, raising the important question, "Which is Good - Predicting or Reacting to the Stock Markets?"

Speculative Stock Market Predictions

The speculator and day trader constantly attempts to predict the market.  He attempts to make a judgement whether the market is likely to go up or down based on various inputs, like behaviour of other markets that had closed overnight after his own market closed, whether the market that opened before his own market is up or down, data about unemployment, GDP growth, so on and so forth. Based on his assessment of the available information he places his bets.  

He buys shares with an intention of selling them the same day at a higher price and pocket the gains. Sometimes he sells shares that he does not even own, with an intention to buy them back when the price falls, again hoping to make a gain. This is called short selling. 

Since these stock trading gains are insignificant after deducting brokerage, taxes, etc., brokers encourage the day traders to leverage the size of the trade by permitting placing of orders by over five to 20 times the available money (margin). This facility of placing leveraged bets is called margin trading. Margin trading enables the insignificant gains to be magnified to a reasonable size, so that the gains are meaningful.  But, this is a double edged sword.  If the bets fail, as most often they do, the losses too are magnified many times.

Television channels, including respectable ones, churn out relentless, 24 hour, debates, stock market predictions and share predictions by the so called experts, for enhancing viewership as well as filling the air time.

In short, all the so called financial market buzz is centred around day traders or speculators and focussed on trying to predict how the markets are likely to behave.

History shows that attempts at market prediction lead to ruining of health as well as financial stability of thousands of innocent speculators, who are given respectability by the brokers and media by bestowing upon them the title, 'investors'.

On the contrary Warren Buffet states categorically that he never attempts to predict markets, since markets are inherently unpredictable.  Instead, he simply reacts to market events and happenings. Meaning, if the markets fall unreasonably he will decide to make large purchases of shares of those companies which ha has already researched thoroughly. On the contrary if he finds that the markets are at unjustifiably high levels he may refrain from buying shares and instead put his money into fixed income securities like bonds.

Conclusion

History proves conclusively that stock market forecasts, stock market outlooks, stock predictions are exercises in futility. Therefore, value investors, following in the footsteps gurus like Benjamin Graham and Warren Buffett, never indulge in predicting the stock markets.  They only react to them, thus burying the debate, "Which is Good - Predicting or Reacting to the Stock Markets?"