Home >Market >Mark-to-market >Should investors in IPOs go for short-term pop or long-term gains?

InterGlobe Aviation Ltd, or simply IndiGo, has had a dream debut on the bourses. Its shares are trading 37% above the issue price of 765. On the other hand, investors found the valuation of Coffee Day Enterprises Ltd too hot to handle. Its shares are trading 20% below the issue price.

Purists say that getting excited about the so-called listing pop doesn’t make much sense, and what matters more is long-term return. That should go without saying. But initial public offerings (IPOs) data suggests that incentives are skewed, and promote a culture of short-term opportunism.

Only three in every 10 stocks have delivered double-digit annual returns for a long-term IPO investor. Five stocks delivered negative returns, and in the remaining two, investors may have been better off parking their funds in safer fixed-income instruments.

In comparison with these pitiful long-term prospects of IPO investments, the chances of making short-term returns are much higher. Over 60% of these stocks listed with double-digit gains. And only a fifth ended the first day of trading in the red. Whatever the purists may say, how can one blame Indian investors for preferring to ride their luck with prospective listing gains?

It’s evident from the poor long-term performance that Indian IPOs are, by and large, overpriced. Giordano Cogliati et al from the University of Bergamo, Italy, had found in a February 2010 study that the median IPO firm in France, Italy and Germany is overvalued at the offering (issue price) by 74%.

What about the correlation between listing gains and long-term performance? Interestingly, it turns out that stocks which gain meaningfully on listing stand a better chance at providing decent long-term returns. Among stocks that gained over 15% on listing, two-fifths, or 40%, ended up with double-digit annual returns in the long run. Among the other stocks that didn’t do too well on listing, only around 15% have managed double-digit annual returns till date. The data is for the past 25 years, excludes stocks with a market capitalization of under 500 crore at the time of listing, and those that don’t have a trading history of at least five years. It also does not include returns from dividend income.

In other words, IndiGo’s shareholders have a higher chance of earning decent long-term returns, compared with shareholders of Coffee Day Enterprises. To be sure, the data also shows that this can’t be taken for granted. In fact, two-fifths of the stocks with handsome listing gains ended up with negative returns, while one-fifth generated only mediocre returns. For instance, Suzlon Energy Ltd’s shares had gained over 35% on listing, but its current valuation is just one-fifth of its IPO issue price.

Among stocks that performed dismally on listing, Cadila Healthcare Ltd stands out, with its shares nearly halving when it listed in April 2000. But using its issue price as the base, average annual returns have been an impressive 22.6%.

Sadly, returns such as these are few and far between.

The writer does not own shares in the above-mentioned companies.

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