Why are retail investors obsessed with IPOs? | Mint

Why are retail investors obsessed with IPOs?

Investors back then had not adequately recognized the potential of Infosys and hence were reluctant to invest in a company that would later go on to become a retail favourite.
Investors back then had not adequately recognized the potential of Infosys and hence were reluctant to invest in a company that would later go on to become a retail favourite.

Summary

  • Initial public offers in hot demand may grant subscribers good listing-day gains in proportional terms, but the slim chances of getting a good chunk of shares allotted in the first place make the absolute gains modest.

A key life-skill is the ability to know when to use percentages and when to use absolute numbers. But many retail investors in the stock market never really get around to learning this skill, which may explain why they go chasing initial public offerings (IPOs) of companies for listing day gains.

Take the recently concluded IPO of Tata Technologies. The issue price was 500 per share, with the stock listing on the exchanges at around 1,200. So, retail investors who managed to sell their newly issued shares at 1,200 would have made a huge gain of 140% on the issue price, and that too in a very short period of time from the day of applying for the company’s shares to the day of its listing. Investors investing up to 2 lakh in an IPO are categorized as retail investors.

So, did it make sense for retail investors to get excited about this IPO? Not really. The retail portion of the IPO was subscribed around 16.5 times, implying that on the whole, investors got two shares for every 33 they applied for. Of course, this was on average, and hence, many retail investors did not get any allocation at all.

Now, let’s consider someone who had applied for and got the minimum order quantity of 30 shares. At an issue price of 500, this meant an investment of 15,000. Investors who had sold their shares at the listing price of 1,200 would have received 36,000 for it and made a profit of 21,000 or a gain of 140%, ignoring taxes, the fact that the money was locked for a few days and other expenses. Now 21,000 is pretty good for a day’s income. But other than a brief thrill, it didn’t change the investors’ lives in any meaningful way, implying that looking for listing day gains cannot be a wealth generation strategy.

Another example here is that of Zomato, which listed in late 2021. The retail part of its IPO was subscribed 7.5 times. Given such huge demand, on its listing day, the share price opened at a premium of a bit more than 51% over the issue price. But many retail investors didn’t get an allotment at all. And among those who did, the gains were limited to a few thousand rupees—delivering brief excitement, a small gain in absolute terms and a talking point for a few days among peers, but nothing more than that.

The chance of getting an allotment is inversely proportional to the demand for an IPO. Given this, even if the share lists at a very large premium, the gains made often do not amount to much in absolute terms.

Also, not every IPO which opens with great fanfare delivers returns over longer spans of time. Take the case of Reliance Power’s IPO in early 2008. The retail portion of the IPO was subscribed 13.6 times. The issue price of the share was 450. It listed on 11 February 2008 at 547.8, a premium of around 22% on the issue price. It touched a high of 599.9 during the day, finally closing at 372.5. So, those who sold as soon as trading started would have made listing day gains, but those who held on were sitting on losses. Of course, the company has been a huge wealth destroyer over the years, with its current share price of around 22.

Then there is the case of Infosys. When the company came up with its IPO in February 1993, it was in danger of being undersubscribed, with the underwriters of the issue having to pick up the unsubscribed portion of the issue. Investors back then had not adequately recognized the potential of Infosys and hence were reluctant to invest in a company that would later go on to become a retail favourite.

Another great story is that of Bharti Airtel, which had its IPO in early 2002, with an issue price of 45. The stock was listed on 18 February 2002, but by the end of the year, its price had halved to around 22-23. Again, as was the case with Infosys, investors did not immediately realize the potential of this telecom company.

So, what does all this tell us? First, demand for an IPO doesn’t necessarily translate into substantial gains over the long-term. Second, higher the demand for an IPO, better the chances of good listing day gains in percentage terms, but since the chances of getting an allocation are lower too, the scope for absolute gains is also lower. Third, an IPO is not the only chance a retail investor gets to invest in a company’s stock. It can be bought at any point of time after listing. Fourth, if retail investors estimate that a stock has a good potential, they should gradually accumulate that stock over a period of time, given that their financial position may not allow them to make large purchases of the stock at one go. Indeed, genuine wealth creation for retail investors from stocks happens from purchases after the IPO. Fifth, making money over the long-term is boring. For a retail investor, nothing can beat the excitement of getting an allocation in a hugely oversubscribed IPO, followed by friends and acquaintances talking about it, perhaps even feeling jealous, and finally, making listing day gains. But do remember that these gains look large only in percentage terms. And, as said at the beginning of this piece, in life, it is important to understand when to consider absolutes and when to use percentages.

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