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IPO Myth

The whole IPO pricing debate is based on the myth that retail investors should invest in public issues

The Securities and Exchange Board of India (SEBI) chief CB Bhave said a few days ago that initial public offers (IPOs) were failing to get good response because promoters were being greedy and investment managers were pricing issues too high. The problem of IPO pricing has now been commented upon on and off for a long time. About a year ago, company affairs minister Salman Khurshid had said that the government was examining the issue of companies setting very high IPO prices and planning to come out with a set of guidelines on fixing a price band of IPOs.

This is a market in which there are sellers (manufacturers and their advisors) and there are buyers. The operative word here is market. If a product isn't selling, then it is the seller's responsibility to fix problem. There is something wrong with either the price or the product itself or perhaps even the message that the buyer is getting about the product. It can't possibly be the buyers' fault, as petulant statements from some sellers seem to suggest. Since this is a market, by definition the buyer is always right. However, promoters and other existing shareholders also have a right to get as much as possible from the new shareholders.

These forces have generally been in balance, with the pendulum swinging one way or the other depending on the way the stock market has been doing on the whole. Throughout the last couple of years, the IPO investor has actually proven to be quite sensible about what he is doing.

The problem only arises when we start making two assumptions - First, the individual retail investor should be investing in IPOs and second, when he does so, he has a right to make a good profit. Drop these two myths and all problems will go away. IPOs are just a different method of buying stock that, despite the mythology, actually makes it more difficult to make money. It is less suitable for the retail investor because typically the company's business success is either in the distant future or it has spent a much shorter time in public scrutiny. The quality of information and analyses available on stocks is actually better in the secondary market.

The problem of IPO pricing disappears when we take retail investors out of the equation. IPOs are ideally meant for institutional investors who can do the appropriate amount of research and properly evaluate the track record of the promoter and the investment banker.