I know a lot of people who are convinced that equity investing is basically buying the newest IPOs and selling out for listing gains. I, on the other hand stay away from most, if not all new listings and let’s build my case why you’re better off not putting your money in the next big thing.
An IPO( Initial Public Offering) is a way for the promoter/existing shareholders to offload their stake in a privately held company, either partially or fully by selling a part of company’s equity(shares) to general public on a stock exchange. This money is either used by the company to fund growth or more so is an opportunity for current shareholders to sell out at a much higher price.
If you’re an owner of a company, assuming it to be well run and a profitable enterprise, what is the sole motive for you to sell 10% of your shares on a stock exchange to general public? To maximise value of your remaining stake so that your networth can be multiplied publically if your company’s shares go higher. And for this, you want to sell your existing shares at the maximum possible price. Assuming you sell 10% of your company in a 1000 crores IPO, the remaining 90% is worth 9000crores! And ofcourse, if the stocks double, your remaining stake will also double to 18000 crores.
Now let’s see how this IPO works. The owner wants to sell 10% of his company and try and raise let’s say 1000crores. Since he is a normal guy running his business, let’s say a food company, he doesn’t know anyone who will buy his 10% for 1000crores. So he hires one or two Investment Banks, let’s say ICICI Securities and IIFL. These two banks promise to underwrite this issue for 1000 crores. This means that they promise to find sufficient buyers who are willing to pay a total of 1000crores(atleast) for 10% of this company and if they find buyers only paying upto 900crores, they promise to buy the remaining 100crores worth shares ( this is called underwriting) from the company. Ofcourse, they will charge 1-2% of the total issue, if not more, as their fees for this transaction.
Now as a retail investor, you can’t buy the entire 1000crore issue, even if you and your entire family sell everything you have. In case you can, you’re not a retail investor anyways! So most of the issue is sold to Big Banks, Mutual Funds, Foreign Investors etc.
The rest of the cake, hardly 2-10% is reserved for the entire universe of retailers. Let’s say the quota for retail investors is 50crores. Also, assume that the issue price is 500rs. So the maximum number of shares retail investors can buy is 10 lakh. The minimum application per retail guy is let’s say for 25 stocks(Rs. 12500 per application). So a total of 40000 investors can buy the total stocks on offer, reserved for retail investors. Now you know that there are close to 1 crore active retail investors. Assuming 10% of them apply for this issue, which means 10lakh investors apply. So out of 10 lakh, only 40000 people will get the allotment of shares. This simply means, out of 100, only 4 are lucky enough to get their hands on this issue. So your chances of success is anyways very low.( 4%)
Now assuming you’re the lucky one and you get your 25 shares at 500. The stock is a hot cake and it lists at 1000. So you quickly sell it out and make 12500 for little to no work. Congratulations! You feel like the Master of the Universe and can do no wrong. Now let’s work this math out. You have made 12500 Rs. After paying 15% short term capital gain tax, you’re left with 10625 Rs. Now ask yourself as to what all can you do with this huge amount of money. Not too much, actually. This is the typical छोटी छोटी खुशियां trap one fall into! You can argue this is free cash but this is too less to matter. This won’t even pay for your one month’s living expenses.
On the flip side, this seduces you to treat the stock market as a giant casino. You lose the incentive to think big, invest long term and create wealth. Assuming you’re always the lucky 4%, the probability of listing gains each time is miniscule. Remember Reliance Power? SBI Cards? For every IRCTC, there is always an RVNL.
However, in Indian markets, there are times when IPOs can make good money. This is when the seller is in distress. Our good old Government of India always sells it’s family silver at throwaway price to keep up with the budgetary divestment targets. In this race to bottom, it divests it’s stake at very low prices. These can be good opportunities to lap up stable quality companies.
My limited point is to warn you from falling for the short term small gains while you can safely put money in good quality stocks and build substantial wealth over time. Anyone who sold Maruti on listing gains misssed out its journey from 200 to 10000 in 15 years. The stock market is not a casino. Don’t gamble with real money. You’ll regret when it’s too late in the day!
Life is all about Compounding! 