Learning from IPOs | Value Research What you can learn from the mega losses in the stocks of new-generation companies
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Learning from IPOs

What you can learn from the mega losses in the stocks of new-generation companies

Are you a new-generation investor who is currently unhappy with the way the markets have treated new-generation stocks? I don't know whether this is any comfort to you but you are not alone. There seems to be an unusually large cohort of investors who are roughly in the same situation. Many of them are particularly unhappy because the 'new-age digital IPOs', which had seemed like such a sure bet, have all basically tanked. Some, maybe many, have made catastrophic losses in their trading and investing over the last few months, both in these digital IPOs and the secondary markets.

There are a few characteristics that make equity investors likely to make large, possibly catastrophic losses. These are: young age, margin trading, derivatives trading, short experience and great enthusiasm for all IPOs. At this point, a lot of you will be up in arms pointing out personal or anecdotal exceptions. I'm sure there are exceptions. However, that's not the point at all. This is about trends and probabilities. All these characteristics increase the probability of catastrophic losses and traders who have many or all of them are practically certain to hit such losses in short order.

As with many such axioms, to appreciate its truth, consider the reverse. Think of a stock investor who combines the opposite of all these characteristics. That's someone who is in their 40s or older, buys cash for delivery, invests only in stocks and not 'effendo', has been an equity investor for at least five-six years or more and invests in very few IPOs, if any. I've built a sort of profile of typical characteristics here but without even going into what people actually invest in, if you know anything like twenty or more investors, you know the truth of this statement.

In my experience, the first type of investor often becomes the second. Not all, but most do. It's a stage that people have to go through. The crazy thing about equity investing (and perhaps many things in life) is that it looks much easier from the outside and in the beginning. The IPO problem makes it worse. Somehow, IPO investing looks even easier. There's none of the mess of deciding when to invest, what price to buy at, whether to spread out the trades or buy at one go, etc., etc. You can read and listen to all the spiel being put out by the IPO companies, absorb the large quantity of gyan that is being distributed free of charge on social media and then you invest. IPO investing feels easier.

Historically too, in India, IPO investing was considered more suitable for the beginner investor. That was probably true at one point but that's old history now. Now, IPO investing is essentially a learning technique where beginners learn that the hype is not always true. In an IPO company, in any IPO, the management is always at an advantage compared to the investor simply because the information advantage lies with the former. As Warren Buffett said, "An IPO is like a negotiated transaction - the seller chooses when to come public - and it's unlikely to be a time that's favourable to you."
After a while, investors realise that there is no real way to make a predictable bet at an IPO. Did you know that Infosys' original IPO actually failed to garner enough subscription from the public? It devolved and the merchant banker had to step in? Compare that with what has happened to these digital IPOs of profitless businesses like Paytm and others.

The ideal approach to IPOs, not just for new investors but all investors would be not to approach them at all. Stay away. There are always better alternatives in the secondary markets at any point. However, if you cannot resist the lure, then go in with the knowledge that it is a high-risk bet, even if it does not look like it. I've often advocated a 'fun money' allocation to frivolous stocks; perhaps it's also advisable to have a small 'learning fee' allocation with which you can invest in IPOs. The net output is less likely to be money, and more likely to be the learning that you should avoid IPOs. It may be worth it.

Also read:

A new hype train sets off

An impossible IPO problem

This editorial appeared in Wealth Insight April 2022 issue. To read the cover story and other insightful analyses, columns and articles

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