How to make money from mega IPOs

The mega IPOs (initial public offerings) are back on the horizon. The biggest sensations of the last few years have undoubtedly been the two 'IPs'. IPL and IPO.

The Indian Premier League (IPL) and the Initial Public Offerings (IPOs) that hit the market with regularity till the cycle of economics caught up with them.

There was a time when even youngsters were discussing IPOs, what with so much publicity given to mega offers.

It was a huge wave and that carried many small investors along its tides and took them to great heights. That was till gravity acted and it came crashing down.

It happened suddenly making many investors grasp the reality that the stock market might be the best way to let your money work for you but not the easiest way.

There were too many similarities to the 20-20 version of cricket, which never augured well for the stock markets.

Why this discussion of all the negatives at this juncture again? Well, the subtle but steady activity building up in the IPO domain is indicating that there is another wave forming.

The restlessness of the 20-20 stock market players could probably make this a high wave too. So, what should small investors do? Do we take our surfboards and ride the wave too, or settle for the wave to hit the shores and put our monies.

Well, there's no perfect answer to the above questions. But, yes, there are certain fundamental principles to help us find out what suits us right.

Back to basics

One of the most important mistakes made in the previous wave was the sheer disregard to fundamentals while investing in IPOs.

This was due to the huge hue and cry over IPOs and how they gave bombastic returns on the first day of listings.

'Hey, I brought XYZ Company at Rs 175 in the IPO and it listed at Rs 230! -- such were oft heard sentence in most offices and discussions, which fuelled higher investor (uninformed mostly) interest in IPOs and the next one was even bigger and so on.

As an investor, we need to understand that the stock market is more a science and less an art. Investing in an IPO basically means investing in the idea of the promoters.

It also means investing in the faith that the domain/industry has a sustainable opportunity to give good profits. This should form the foundation of our investment.

Don't invest because you have spare money

Just because you have excess money in your bank account, it does not really mean that you should go in for an IPO available during that period.

Look at yourself as a business man and understand if you would do the same business with your money if you had all the necessary technical expertise? The answer to this should give you a clear idea of whether to go forward or not.

Would you buy the service/products that the company coming up with the IPO is planning to sell? What is it that this company is offering that no one else has offered or is offering? Do you feel the guys at the top of the company are trustable enough to:

• Lend them your hard earned money
• Running that particular business!

If you feel that the same idea is already in the market and many others are doing it, then, ask yourself if this company has something unique that could help it not only create profits but also sustain them?

Surely invest if you strongly feel about the idea

Corollary to the previous discussion, if you do not have the money and yet feel very strongly about an idea/company based on strong fundamentals, then it would do no harm to garner resources and invest in the IPOs.

Yes, many pundits do say that it's better to avoid the IPOs as the stock could be available at a cheaper price sooner in the secondary market.

True, but, not always. The judging factor thus brings us to the next deciding factor.

Is the price right?

Many investors, who are new to the markets are not clear how to find out if the pricing of a stock is right or not.

The easiest thumb rule to is do a comparison with existing stocks listed in the market which are similar to the company coming up with the IPO.

Put the price on a weighing scale (metaphorically of course!) and find out if the price overweighs the benefits or vice versa. This, as mentioned earlier is a thumb rule, but, good enough to give you direction.

Also if you feel that it's way beyond your budget even if it's probably right its better to avoid buying it in compulsive lots during the IPO and rather buy it in the secondary market.

Is it worth it?

One final thumb rule is to divide the total amount being raised by the IPO with the total value of existing assets. Anything above 3 should ideally be avoided.

This concept in simple terms is to help us understand the efforts taken to build the assets/orders currently in the hands of the company and whether the amount being asked from the market is reasonable based on that parameter.

Example:  A classical example was the Reliance Power IPO.  Although Reliance was expected to achieve 28000 MW of power production only in the year 2016 its price band for the IPO was 405-450. This meant that it wanted to raise around Rs 11,500 crore (Rs 115 billion) when we already had an existing company (NTPC) trading at around Rs 260 and an existing production of 28,000 MW. Who would you go with? Someone who already is at 90 M mark in a 100 M race or someone who is at the starting line?

Facts:

• Then: Reliance Power opened at Rs 516.33 and closed at 351 on 11 Feb 2008, the same day NTPC was trading at 206.
• Now: Reliance Power (August 19, 09) trading at Rs 155 and NTPC at Rs 203 levels after reaching a 52-week high of 233.