Wednesday, April 18, 2007

When to Say No to an IPO

Are you planning to invest in an IPO either because you are getting the shares at par value or because the company you are investing in is sound and stable? WAIT!! Play safe and ensure you are not duped.

Par value is the face value of the share. This par value is arrived at through an accounting decision and bears no relation to either the intrinsic value of the company or how the public view the company. For example, XYZ Co. share has a par value of Rs 5, but it's market price could be around Rs 3,000 per share. When the share is traded in the stock market, however, this value may go up or down depending on the supply of and demand for the stock. If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and/ or many want to sell them, the price will fall. This price is referred to as the market price. A share with a face value of Rs 10 may be quoted at Rs 55 (market price higher than the face value) or even Rs 9 (market price lower than the face value).

The fact that you are getting shares at par value is no guarantee that the company is going to do well and you are going to rake in big bucks. Often, most companies come out with shares that are at a premium to their face value. Those that come with shares at face value seem to appear more alluring.

Some companies whose shares are already available for trading come out with a fresh lot of shares. This is referred to as a new issue or a Follow-on Public Issue (FPO). A common bait investors fall for is the fact that the price of the new issue is cheaper than the current market price. For example, the current market share may be Rs 100, while the FPO may be offered at Rs 90.

Don't let this be the only reason you buy those shares. Sometimes, the prices of the stock may get manipulated in the market to keep the prices high before a new issue is announced. So, while you think you are getting a good deal because the shares are available at a discount to the market price, the reality is that the market price has been artificially hyped up because of manipulation by brokers.

A share that is being oversubscribed does not mean it's a good investment for you. The process is that investors have to bid for shares in an IPO. When the bids exceed the number of shares, the issue is said to be oversubscribed. There could be a number of reasons why this happens.It could be that many banks and financial institutions are liberally offering loans to apply for the issue. This could result in oversubscription. Also, institutional investors (as against retail investors like you and me) don't have to put up money upfront when they make their bids. That means they can put in any amount of bids, hoping that the resulting hype about oversubscription will lure more investors.

At the same time, just because you are investing in a sound and stable company, it does not mean you have to pay a very high price for it. It would be a futile investment if the company was excellent but the price of the issue was sky high.

So think about these issues next time you go shopping (IPO shopping that is ;-) )

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