Investing in euphoric IPOs versus listed stocks: Which is worth it and why?

In such times, the alternative abbreviation for IPOs can be "Instant Performance Opportunity" instead of "Initial Public Offering" because, in the last 2 years, investors have gone on a frenzy to buy IPOs. This sudden rush of retail investors' interest coupled with a good appreciation in stock prices has brought forth a new norm: overvaluations in the IPO market.

Since April 2014, the S&P BSE IPO index has given an aggregate return of 180%. This phenomenon has resulted in a few noteworthy developments. Firstly, many small and large private companies are gearing up to go public and raise capital from the market because they can get rich valuations. At the same time, the Government of India has been tapping into the public's appetite to buy stocks by listing public sector companies and cashing in to meet planned expenditure requirements. In combination, these activities are sucking out a lot of liquidity and thereby impacting the long-term potential of the secondary markets if the rate of fund flows slow down.

The number of IPOs has been increasing since 2014 with a very high success ratio. Almost all companies that planned to raise capital have succeeded and the stock prices have performed very well even after high valuations which most of them were listed at. Also, the amount of capital being raised has gone up substantially and is currently at all-time highs. For instance, In 2014 there were 7 IPOs that raised 1,200+ crores.

In 2015, there were 21 IPOs which collectively raised more than 11,000 crores. In 2016, there were 27 companies that went public and raised some 26,000 crores and this year we have seen a total of 34 listings with a total fundraising of 60,000 crores so far. Of the total amount raised in 2017, more than 50% has come from the financial service sector primarily insurance companies which are large issues. In the future, we are going to see many asset management companies monetize their businesses by going public as well.

Although newly listed companies have performed well so far, it is yet to be seen if they can sustain the current valuations when the euphoria wanes out in the future. Every listing requires a nod from SEBI which has recently asked for clarification from 10 companies (Lemon Tree Hotels, CMS Info Systems, ACME Solar holdings, Seven Island Shipping etc.) and put some on hold like Barbeque Nation (A restaurant chain based in Bangalore). A sanity check on aspiring companies is a crucial activity and will ensure that only compliant companies with a clean track record will be eligible to tap the public markets to raise capital.

It is important to understand that most investors in IPOs are looking to make quick profits and sell on the rise. So, their investment logic is purely speculative and based on the euphoria in the markets. The recent demand for IPO funding solidifies this trend. Investors are willing to borrow money for 7 - 10 days from brokers and trade high flying IPOs with leverage. From a long-term investment standpoint, IPOs are not necessarily the best entry point. It makes more sense to observe the growth rate of the company for a few quarters before buying the stock. It is a more conservative approach but that's what medium to long-term is all about; making rational decisions.

Currently, investors have factored in a huge growth rate in newly listed companies and also small caps. If these companies fail to keep up with expected growth rates, then share prices could correct significantly. There are a lot of turnaround opportunities in the listed space which can become multi-baggers in the future. The highest returns don't necessarily have to come from IPOs. For instance, in the last one year sectors like retail, plastics, sugar and gold finance companies have given higher than 65% returns. Commodity stocks have also outperformed the markets significantly too and such opportunities will continue to exist in the future.

By Tejas Khoday, Co-Founder & CEO, FYERS (A new-age discount brokerage with innovative platforms)