Great Indian IPO Rush 2021: Why The Retail Investors Should Exercise Extreme Caution

With several companies filing for Initial Public Offerings, investors in the primary markets are spoilt for choices today. So far, 32 companies have filed for IPOs and have raised total of Rs 45,670 crores – the highest numbers in the last three years.

Several high profile companies like Paytm, Nykaa and PB FIntech (the parent company of PolicyBazaar) have already filed their Draft Red Herring Prospectuses (DRHP) with the Securities and Exchange Board of India (SEBI). Until now, 2017 had been the best year for IPOs – 38 offerings mopped up Rs 75,279 crores. However, with large tech start-up IPOs lined up, 2021 might take the top spot.

Though the markets were choppy in the first half of 2020, retail investors have been extremely enthusiastic participants in the markets since the second half of the year. Fuelled by low interest rates, the markets have been moving upwards at a rapid pace.

The retail segment of the Burger King IPO had been subscribed 68 times, implying extremely high demand in the market. Among IPOs in the past year, the retail segment of Nureca Ltd was subscribed the highest at 167 times.

Similarly, IPOs of others such as Nazara Technologies, Happiest Minds Technologies, Easy Trip Planners, Burger King India, Chemcon Speciality Chemicals, Mazagon Dock Shipbuilders, Mrs Bectors Foods and MTAR Technologies all saw their retail segments subscribed between 28 and 166 times.

On the fourth of August 2021, four IPOs were launched together and each was oversubscribed in the retail category. Usually bankers prefer to stagger IPOs, but with the optimism in the markets, the bankers are striking while the iron is hot.

In January 2020, the total number of investor accounts with the Central Depository Services Limited (CDSL) reached 2.01 crore. The last 17 months have almost doubled the number to 3.96 crore accounts by June 30 2021. According to reports, over the last six months since December, CSDL has observed the addition of 1.07 crore accounts, which means that around 27 per cent of investors have entered the markets during the last six months.

The numbers quite clearly indicate that most of the retail investors lack experience and quite possibly, knowledge. Many of these investors have never witnessed chaotic markets and might have misplaced expectations about the returns the markets offer.

Even then, applying to an IPO is easier than ever. Investors can apply for IPOs through the UPI payments system without going through any hassles. Some discount brokers, whose primary customers are young retail investors, send emails urging investors to buy into these IPOs by highlighting the strengths of the companies. Such practices can subtly encourage unjustified risk-taking, finally resulting in a permanent loss of capital.

Recent IPOs have been looking to exploit the extreme optimism in the markets. Most of the companies that have filed for IPOs have extremely high valuations. The Krsnaa Diagnostics IPO is priced at an earnings multiple of 70x, while Zomato became one of the highest-valued companies in the country despite never having turned a profit.

Overvalued and perfectly valued companies rarely, if ever, yield high returns for investors. If one invests in a company solely because it is popular in the market, one cannot beat the market because by definition, one becomes the market. Uber and Lyft, both are listed new-age technology companies which have failed to deliver returns for their investors over the last two years.

According to reports, margin financing has contributed to the IPO boom. In July, ten companies raised Rs 18,400 crore through the primary markets, but their IPOs received bids worth nearly Rs 8.86-lakh crore. Nearly 98 per cent of this subscription money came through margin financing. Institutional buyers have been active in the IPO market to exploit the demand-supply difference in hot IPO stocks. These investors have no regulatory limits placed on their buying capacities during IPOs and can avail high leverage at low rates of interest, giving them an advantage over retail investors.

Until the third of August, 21 out of 28 IPOs had given their investors a first-day listing gain. The leveraged institutions usually sell the stocks on the listing day, pay the interest and pocket the difference.

Despite these issues, the current IPO boom led by technological stocks certainly indicates a change in investor sentiment. Public markets are known to focus on profitable companies; however, it appears that the markets are ready to fund loss-making technological start-ups.

The sentiment partly stems from a scarcity premium that investors place on the few listed companies from high-potential sectors. In addition, these companies are free from the usual corporate governance issues found in most promoter-run Indian companies. A strong global investor base also ensures transparency and high governance standards.

Liquidity has fuelled the markets and with it, the retail investors’ fortunes. But, with rising inflation, central banks might raise interest rates and lower the liquidity in the system, resulting in lower valuations. The pricing of these IPOs does not leave much on the table for investors. A large portfolio allocation to these highly-priced IPOs can be risky, especially if growth flounders.

The high valuations price-in high growth rates for long periods of time – a rare phenomenon in the competitive business world. History has shown that investment bankers, banks, venture capitalists and institutions make money while retail investors do not. Investors must stop operating on “tips”, hearsay or emotions and start thinking for themselves.