Be Wary Of The Chimera
If you invested Rs 1,000 into each of the 249 initial public offerings (IPOs) that have hit the domestic bourses since 2010, and held on to each one - your cumulative fund value as on date would be Rs 389,229 as on date -translating to a paltry annualized return of 6.55 per cent1. In fact, you would have lost money on 135 of these 249 IPO's. In over 90 of them, you would have lost half your capital. Only 23of these IPOs would have rewarded you with a double-digit annualized return over a five-year holding period.
Take away the 30 odd IPOs that have been benefactors-in-chief of the liquidity fuelled rally that has characterized the past year, and the numbers look even more abysmal. You would actually have been better off investing into a passive NIFTY index fund through monthly SIP's!
In this classic example of the survivorship bias, the Jubilants, the Persistents, the Lal Pathlabs and the CDSLs hog the headlines; while the Talwalkars and Jaypee Infras are relegated to the dusty corners of our minds. Indeed, as Rolf Dobelli stated in his book The Art of Thinking Clearly, visiting the metaphorical cemeteries really is a vital part of any sound decision making framework.
The Fomo Factor
Why do investors keep flocking to IPOs despite overwhelming evidence that they will turn out to be a suboptimal longterm investments? The two chief reasons are - FOMO (Fear of Missing Out), and the prospect of listing gains.
The trouble begins with retail investors acting on incomplete information. Only a very small fraction of investors actually take the pains to do any homework about the company they are buying into. Most of them just buy into the advertising fuelled mass hysteria, and the cascading FOMO that follows. The broking community obviously has its interest aligned towards pushing these IPOs, and so they sell the entire "flip upon listing" narrative to the hilt.
'New Age' IPOS
In a sense, the long-term underperformance of most IPOs is written in stone the moment they are launched. Think about it - if you were a promoter looking to either monetize your stake or raise growth capital, when would you time your IPO? During the hellish throes of a bear market, or at a time when the froth is joyously bubbling over? Obviously, the latter. What does that say about IPO valuations?
To add another layer of complexity into the mix, we now have "new age" IPOs hitting the markets. Since these companies are yet to turn a profit, they cannot be valued using traditional models such as discounted cash flow or earnings multiples. Paytm lost more than Rs 1,700 crore in FY 2021, and Zomato more than Rs 680 crores in the nine months ending December 2021. Their IPO valuations? Astronomical, of course. Time tested concepts like "margin of safety" or "growth at reasonable prices" go out the window.
Future Ready
The question is, why are so many people queuing up to own a chunk of an unprofitable company?
The short answer is, they are buying into the future. Outstanding examples such as Twitter and Amazon clearly prove that if you have a large, deeply engaged retail client base in place, you could, with some luck, eventually make your business profitable. Twitter turned its first profit more than five
years after listing. Amazon famously burned cash for 17 quarters after hitting the stock exchange for the first time.
That pivot from "cash guzzler" to "cash positive" is both nonguaranteed and unpredictable, though. And therein lies the problem - what investors are doing is, betting that these businesses will become profitable at some point. And what if they don't? Well, the simple answer is - it'll all come tumbling down.
The Potholes
Take Zomato. What if the restaurant lobby puts brakes on its progress? What if a competitor with a paradigm shifting new product breaks the Zomato-Swiggy duopoly and usurps both? What if skeletons come tumbling out of the closet, Foodpanda style? The number of "what-ifs" that exist between today's cash burn and tomorrow's profitability are numerous. Do these "what-ifs" not cast a cloud over the rich, "25X enterprise value" IPO price that the company is commanding?
Bottom line? Take new age IPO's with a pinch of salt. Don't dive in because of FOMO. And if you do, know that you are speculating; not investing. When you speculate, you must do so with the complete acceptance of the fact that you may very well end up losing a large chunk of your capital.
Rational Decisions
Should you steer clear of these offerings altogether? No. It's quite likely that many of these businesses will complete that "pivot" into profitability at some point. Use your intelligence and rationality to make wise long-term investment decisions instead of joining the frenzied, feverish hordes of speculators chasing ephemeral listing gains.
If you believe in the future of these companies, allocate a fixed portion (say, five per cent or 10 per cent) of your portfolio to them in a disciplined, structured manner, much like a mutual fund SIP - and for the long term.
And for the best part, make avoiding IPOs a general rule of thumb. Remember, you'll have plenty of time to accumulate these shares after they list!
