In the previous episode, I talked about the money mistakes I have made in my career. But one mistake which I haven’t made, or rather learnt to avoid very early, is betting on IPOs or Initial Public Offers. Many new investors think you can get wealthy by betting exclusively on IPOs. But they’re wrong.  

Hi, I’m Aarati Krishnan, Consulting Editor with Business Line. I’ve been tracking markets and investing in them for over 25 years. In this video, I’m going to give four reasons why IPOs don’t make anyone rich.  

Reason 1# Bunched up in bull markets  

In theory, IPOs are supposed to be all about a small private company deciding to tap the stock market for the first time to raise funds and list on the exchanges. But in practise, IPOs are mostly about the founders, promoters or investors in a private company, trying to sell their shares at highest possible price to public investors – that is investors like you and me.  

If you look at the number of IPOs that have hit the markets in the last 30 financial years in Prime database, you will see that IPOs raised record sums in 1994-95, 2007-08, 2017-18. All of these years had one thing in common. They marked the end of a big bull phase in markets, and were followed by a correction or a market crash. 

The best way to create wealth through stock investing is to invest when fear and not greed, is the main emotion driving markets. Markets in which people are chasing IPOs to double or treble their money in a week, have already been taken over by greed.   

Reason 2# Listing gains are fleeting  

If IPOs are helping people double or triple their money in week and I want to participate in that, what’s wrong you may ask. Have you played the game of musical chairs? As long as the music stays on, everybody’s sure they will be able to grab a chair. When it stops, if you aren’t quick or alert, you are out of the game.  

Listing gains on IPOs are very much like that. As long as the market is rallying and stock prices are rising, IPOs manage to deliver listing gains. The moment there’s even a tiny pause in the market leave alone a correction, IPOs tank below offer price. 

The most famous example of this is the Reliance Power IPO in January 2008 which was oversubscribed 70 times and attracted 50 lakh applications for the Rs 11,000 crore offer. People literally opened demat accounts by the dozens to bid in it, because they thought that listing gains of 80% or so on the IPO price of Rs 450 per share, were almost guaranteed.  

But between January 18 2008 when the IPO closed and February 11, when it listed, the mood in the markets changed dramatically. As the subprime crisis in the US started unfolding, the Sensex dropped 4000 points. So when Reliance Power listed, it was unable to hang on to any gains, and on the listing day itself the stock had dropped to Rs 372, handing IPO investors a loss of 18%. In fact, IPO investors who kept waiting to break even, lost over 80% of their money as the stock never looked up.   

Reason 3# Allotments are a lottery

 To make real money on any investment, you need to be able to put substantial sums to work in it. When you buy mutual funds or stocks in the secondary market, you can decide on a big allocation if you have confidence in your investment.   

But in IPOs, you cannot decide how much to invest, as that is decided by the number of shares you are allotted. Now, investors are required to bid in IPOs in lots. For retail investors, the minimum application amount is one lot which usually about Rs 15,000. Now, if you think an IPO will make listing gains you can apply for many lots. If you apply for upto Rs 2 lakh your investment will be considered in the retail quota. If you apply for more it will be considered in the NII quota.   

Now if the IPO is over-subscribed to a small extent, all retail investors will get allotted one lot, or about Rs 15000 worth of shares. If it is heavily over-subscribed, even allotment of this 1 lot is decided by a lottery. You may or may not get allotment at all. If the IPO is under subscribed, then you can get full allotment for all the shares you applied for. But then such unfancied IPOs are unlikely to get you any listing gains! 

Many investors try to get around this by betting more than Rs 2 lakh in IPOs by availing of loans to apply. Now, by getting into the NII category you can get proportionate allotment if you manage to apply for more lots than the over-subscription in the IPO. But this is risky game. To make money with such borrowed bids, you will need to cover your borrowing costs also on the day of listing. If the IPO fails to list at a big premium you end up with big losses.   

Reason 4# IPO pricing is loaded against long-term gains     

Many people who don’t make listing gains in IPOs turn these stocks into long-term holdings, hoping to make money on them one day. But in the stock markets, your long term returns depend a lot on your entry price. IPOs mostly don’t allow you to buy a stock at a reasonable price because the pricing of IPOs, especially in bull markets, is designed to maximise the gains to the selling investors or promoters. In the last few years, most IPOs have been offers for sale by promoters or private equity investors who have been invested in the firm for long. When they decide to cash out of the business, they try to max out their returns for all the risk they’ve taken. But the IPO investor, is left holding the baby!  

(Host: Aarati Krishnan, Producer: Anjana PV, Editng: Darshan Sanghvi, Camera: Bijoy Ghosh)