At present, the sentiment is upbeat, and companies are waiting to come out with their initial public offerings (IPOs) to cash in on the boom.
Surprisingly, their success will depend on investors' irrationality and greed.
In the past, India had a controller of capital issues to decide the pricing of IPOs. This made subscription to IPOs very profitable and investors made handsome returns then.
On Tuesday, IPOs are priced at market rates. So, technically, an IPO is like any other stock listed in the market. It is not really sought after, something for which people feel that a lucky allotment will make them good money.
However, the penchant for chasing the new is so strong that investors do not see the reality and blindly chase IPOs.
Any company selling shares to public will want the maximum price for its original inventors and risk-takers. So, most IPOs come out in a bull market, when prices are high and irrational investors are willing to pay irrational prices.
In bear markets, prices are depressed. Companies believe their shares are more valuable than the price the market is willing to pay. So, we don't have many IPOs in a bear market.
A company appoints an investment banker to market its IPO. The investment banker acts as the company's agent and helps it get the maximum price.
An investor investing in an IPO relies on information provided by the investment banker and makes his\her decisions on the basis of the research report made by the agent or its associates.
The investor mistakes the investment banker to be a professional advisor, but he\she is just a selling agent for the company.
How can the investor benefit? Even if investors are aware of these facts, their greed and overconfidence makes them fall prey to IPO investing. They believe that although an issue is overpriced, they are smart enough to get out by making a profit before others do.
However, other investors also think the same. Yes, this could work in some issues, but it is risky.
At present, one also needs to be careful of unscrupulous managements and investment bankers coming out with IPOs of fancy sectors.
Do not get carried away by grey market premiums. They are manipulated - remember the grey market premiums of Morgan Stanley's close-ended fund and the Reliance Power issue. They just vanished on listing.
We have seen dot com, power and real estate IPO booms where investors lost money. Investors need to understand that returns come when you buy value. These are not the times to get values and IPOs can never be value buys.
The writer is chairman, Parag Parikh Financial Services. Views expressed are his own.
