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IPO's are not short-term plays
Chandnee Sinha
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August 30, 2007

"Investing for a long term" is what experts like to talk about and investors like to ignore. Especially the retail lot. Retail investors like to invest in initial public offerings only to sell out on the day the stock is listed.

This may not always work out in the best interest of the investor. Flipping IPOs, as this is known as, can be very risky. To know why, read on.

Let us take the case of an investor who decides to invest Rs 1 lakh in a stock which is being sold at a price Rs 100. He hopes that at that price he would get 1,000 shares.

What he hasn't taken into account is the oversubscription.

Oversubscription refers to the situation wherein the number of shares that the investors want to buy is much more than the number of shares the company coming out with the IPO is willing to sell. Let us assume that the IPO is oversubscribed 20 times. Hence for every 20 shares that an investor applies for he gets only one share. So in case of the example taken, the investor gets only 50 shares (1,000 shares/20).

The investor wants to flip the IPO. Hence he has to wait till the stock gets listed. Let us say that there is a gap of fifteen days from the day he applies for the IPO and the day on which the

Now during this period of 15 days, the investor loses out on the interest he would have otherwise got on the Rs 1 lakh that he has put in. If this amount was put in a fixed deposit of 15 days, giving an interest of 6 per cent per year, the investor would have earned around Rs 250, in the 15-day period. This is the notional cost that investors forget to take into account.

This amount of Rs 250 has to be recovered from the 50 shares that the investor has been allotted. What this means is that the investor has to recover at least Rs 5 per share (Rs 250/50) to ensure that he does not end up in a loss making situation. The stock has been priced at Rs 100. Hence to recover Rs 5 per share, the stock has to go up by at least 5 per cent on the day of listing. 5 per cent may sound very insignificant, but it clearly is not.

In the past there have been cases where stocks have given a return of 100 per cent and more on the day of listing. But that period is clearly over now. In 2007, for the stocks that have listed, the average listing day gains have been around 2 per cent.

Also, there are investors who borrow from banks at rates of interest of 18-20 per cent to invest in an IPO. Such investors have to recover the interest they pay to the banks from selling the shares.

If an investor borrows Rs 100,000 for a period of 15 days at a rate of interest of 20 percent, the interest he pays would amount to around Rs 820. If he gets allotted 50 shares, he has to recover around Rs 16 per share.

Rupees 16 per share on a stock that has been priced at Rs 100, would mean a listing day gain of 16 per cent.

As has been mentioned above, the listing day gains during the course of this year has been limited to around 2 per cent on an average. So expecting 16 per cent gains is not realistic.

Also higher the oversubscription, the more the listing day gains have to be for the investor to recover his interest cost. If the stock is oversubscribed by 25 times, an investor investing Rs 100,000, hoping to get 1,000 shares of Rs 100, will get 40 shares (1000 shares/25) only.

So he would have to recover the Rs 250, that he loses as interest on Rs 100,000, from these 40 shares. That would imply Rs 6.25 per share (Rs 250/40) or a gain of 6.25 per cent on the listing day on a share of Rs 100.

The point being made is that flipping IPOs is not as easy as it seems. Especially when the average listing day gain during the course of this year has been around 2 percent.

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