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Nov 15, 2017 11:16 AM IST | Source: Moneycontrol.com

IPOs once again prove Warren Buffett right – they are avoidable

Value investors as a norm do not like to invest in initial public offerings (IPO). Most of them publicly disclose their aversion to it and advice retail investors to stay away from it.

Shishir Asthana
 
 
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Value investors as a norm do not like to invest in initial public offerings (IPO). Most of them publicly disclose their aversion to it and advice retail investors to stay away from it.

As recently as in 2016, Warren Buffett, the quintessential value investor, once again reiterated his revulsion for IPOs. 2016 was a good year for IPOs in the US but Buffett said that he couldn't care less about those who have struck it rich in the frenzy of IPO activity in recent years.

“You don’t have to really worry about what’s really going on in IPOs. People win lotteries every day but there's no reason to let that affect your investing strategy at all,” Buffett said at Berkshire Hathaway’s 2016 annual shareholder meeting in Omaha, Nebraska. “You have to find what makes sense and follow your own course.”

Indian markets have recently witnessed a spate of IPOs but a look at their performance and one can understand why Buffett and his contemporaries prefer to stay away.

Out of the 30 IPOs that tapped the market in the calendar year 2017, 60 percent of them could not beat the broad market return. In fact, over one-third of the issues have given negative returns.

To be fair there were five issues which delivered more than 100 percent returns, but if one considers the numbers of share that were allocated to the lucky few then the actual returns on the amount invested come down considerably.

Unlike the secondary market where there are many buyers and sellers and thus price discovery is possible, IPOs are a one-sided game. A company that is approaching the market, through its merchant bankers, decides the price at which it will issue. If the market conditions are not right they might choose to delay the issue.

Many issues over the past few years in India are offered for sale. In such a type of issue, either the promoter or a private equity investor is looking at exiting their earlier investment.

Professionals view this as an insider with nearly all information who wants to cash out of the company. This could either mean that the future prospect of the business is not too good or the markets are hyped enough to give them a good exit at the high valuation. Both these events are reason enough for a professional investor to stay away from such companies.

This does not mean that all IPOs are bad. Retail investors are still on the look-out for the next Infosys or TCS. But such issues are rare and even if such companies do tap the market the issues are always over-priced. Professional investors patiently wait to participate in such companies when its value comes down below market price.

Retail investors, on the other hand, invest in IPOs for what is termed by analysts as ‘listing gains’. It is this word that sucks in a lot of retail players and proves the professionals' view on IPOs to be correct.

 
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