One is buying from the secondary market. This is the common route to buy shares from the Stock Exchange through brokers. The other is the current frenzy -- buying from the primary market. This means you buy them directly from companies when they make new issues of shares, called Initial Public Offerings.
Why IPOs?
Why would you pick shares through IPOs rather than buy them from the market?
Because, often, companies issue their shares cheaply. Later, when these shares are listed on the Stock Exchange, they list them at a premium (higher than the price at which they were issued).
So you could make a lot of money if you sell those shares.
The Jet Airways IPO had an issue price of Rs 1,100 per share. Issue price is the price at which you can buy a share when you apply for an IPO.
The day it was listed on the stock exchange and was available for trading -- March 14 -- it rose to Rs 1,304.
If you had bought the shares when you applied for an IPO and sold it on listing, you would have made a gain of over Rs 200 per share in just a few weeks.
Earlier, people gained more from IPOs that were not priced as high. These include the TCS and NTPC mega issues last year as well scores of smaller issues, like Biocon, Patni Computers, Power Trading Corporation, Petronet LNG, TV Today, India Bulls, which have all appreciated tremendously in value.
No wonder hordes of small investors are making a beeline for the IPO market. Issues are oversubscribed within minutes of opening.
Why IPOs are not always quick money
Be warned. If the price on listing is not high enough, this strategy might backfire.
Much also depends on the timing of your sale. And timing the market is not easy.
To continue with Jet Airways, if you had continued to hold your shares till May 24, you would have seen the price of your scrip falling to Rs 1,200.
The best reason to invest in an IPO is: believe in the company.
Often, companies that are going public or are listing their shares for the first time offer their shares cheap and go on to become very successful.
IPOs thus offer investors the chance to participate in their prosperity cheaply.
Gains may be the chief attraction of buying in the primary market. But don't let it be the only one.
How to play safe
1. Don't fall for the media campaign!
IPOs are normally heavily advertised in the media. Not only because it is statutorily required but because companies want maximum publicity to ensure their issues are a success. A great campaign does not reflect on the company's prospects. 2. Read the prospectus!
Before applying, be sure to read the prospectus for the issue.
This document invites the public to subscribe to the shares of the company and contains plenty of information on the company's financials, its track record, and what the management plans to do with the money it is raising.
It is free and available on the company's web site or on the SEBI web site.
Please note: there are plenty of not-so-good companies who come out with IPOs, especially when the market is buoyant.
Make sure you know enough about the company and are confident about its management and growth prospects before investing.
3. Look at the price Remember: it is not enough to invest in a good company. The price at which the IPO is being made is equally important. It is no use if the company is excellent but the price of its issue is sky high. In such situations, second-tier companies may be better investments, if the price at which they are being offered is cheap. You can check this out by ensuring that the price is being made at a price to earnings ratio which is in line with other comparable companies in the industry. The price to earnings ratio is the market price of the share (in the case of an IPO, the issue price), divided by the EPS. Earnings Per Share = Net Profits/ Total Number of Shares To understand these ratios better, read How to spot a good stock. 4. Don't get fooled by the 'at par' sales pitch Whether a company offers its shares 'at par' or at a premium is of no consequence. Par value is merely the face value of a share. Many promoters hype the fact that they are offering their shares at Rs 10, or at par, as if they are doing investors a big favour. The point is, the par value of a share is an accounting decision a company makes and bears no relation to its intrinsic or market value. For example, the Infosys share has a par value of Rs 5, but is now being quoted in the market at around Rs 2,100. Don't bother whether the shares are being issued at par or at a premium. Check out the price-earnings ratio and the growth prospects for earnings, instead. 5. Don't get swayed by current prices
If a company that is already listed (has its shares for buying and selling on the stock exchange) is coming out with a fresh tranche of shares, it is called the new issue. As mentioned above, check whether the price offers good value. 6. So what if it is oversubscribed?
Do not get taken in by the news about the issue getting oversubscribed.
Remember: institutional investors don't have to put up money upfront when they make their bids. That means they can put in frivolous bids, hoping the resulting hype about oversubscription will lure investors to the issue.
To read more about the bidding process, read Want to bid for shares? Read this first!
Also remember that many banks and financial firms push IPOs by liberally offering loans to apply for the issue. This, too, results in oversubscription. The best way to make money from an IPO is to subscribe to issues of good companies with a record of consistent growth in earnings that are offering their shares at a reasonable price. That strategy should deliver the best returns. Illustration: Dominic Xavier
P/E ratio = Market Price/ EPS
Prices of the smaller new issues may be manipulated in the market to keep prices high before a new issue is announced. So don't go by the fact that the new issue is being offered at a discount to the market price.