Does investing in IPOs make sense ?

IPO's ... Investors another dilemna

For investors today, there are also more companies to consider than ever before. Every day it seems another batch of companies is going public.

In this highly competitive market, some of them need quick and large injections of capital just to survive. But sometimes this race to an IPO comes at the expense of laying the foundation for a viable, long-term company. As long as investors stay hungry for public offerings, there will be even more IPOs.

When a company goes public these days, the number of shares offered to the public often represents only a small percentage of the company's total shares. Now, simple economics tells us that with heightened demand and a limited supply, the price is going to climb. But when current demand is already at extraordinary levels, the price tends to skyrocket.
By limiting the number of shares that are offered to the public, however, the underwriters, venture capitalists, and other select participants have much to gain. They are the ones who own the rest of the stock that was not offered in the IPO. While the rest of us are scrambling for a few shares and driving up the price, these company `insiders' can sell their own shares down the road for a much higher price.

So the moot question is "Does investing in IPOs make sense?"

Anand rathi group has come out with an excellent report on answering the same question. Some excerpts from the report

"Highlight

Is the euphoria about IPOs justified?
􀂾 The last four financial years saw ~ Rs. 900 billion primary public equity mobilisation.
But the demand is clearly ahead of supply as reflected in large oversubscription of
many IPOs. The question is whether this euphoria is justified?
Do Indian book built IPOs really yield 'abnormal' return?
􀂾 We examine 159 book-built initial public offerings (IPOs) in India between 2000
and 2007 and find two-thirds of these issues resulted in listing gains. But it is disturbing
to note that such gains have eroded sharply in the recent years.
What makes an IPO hot?
􀂾 We explore relationships between listing gain or money left on the table with factors
such as the sector of IPO issuing company, market cap, issue size, valuation, standing
of the lead manager, post issue promoter holding, etc.
􀂾 In general, we find a kind of 'central tendency' whereby mid-cap companies, midsized
issues, middle-aged (7 - 10 years old) companies, issues managed by midsized
investment managers generally yield the best listing gain.
Do investors really gain from participating in IPOs?
􀂾 Due to large oversubscription, significant interest and opportunity cost of funds
blocked during listing period, absolute listing gain is a not a good measure for
realisable gains from participation in IPO.
􀂾 Our exercise on the realised listing gain of different classes of investors show that
such gains are generally much lower than absolute listing gain.
How long to hold an IPO scrip?
􀂾 Our exercise suggests that listing day and around 100 trading days after listing can
be two important exit points from IPO scrip. However, even after 100 trading
days, our IPO scrip index continued to outperform broad market index indicating
'abnormal' return for the buy and hold investors.
What next?
􀂾 Falling absolute listing gains and low realised listing gains are not in line with the
longer term interest of the primary equity market or the economy. We propose
certain measures, which could be explored to address this situation."