How to make a killing in IPOs

Investing in a primary offer is often touted to be less risky than buying shares in the secondary markets. That is because invariably companies come out with public offers to fund their growth plans. Since the cost of raising loans is higher for younger companies, they opt for equity.

From an investor's viewpoint, the idea is really to invest in a company when it is still at the nascent stage and holds promise for growth. And primary offers are also meant to leave some money on the table as a reward for investors who keep faith in the stock even before the company has proved its worth.

But most investors today subscribe to initial public offers (IPOs) not to hold the stocks for a life-time, or even for a couple of years or months. Instead, they look to make a quick buck by selling their shares as soon as the stock hits the bourses.

As more and more individual and institutional investors try to exit the counter on the very first day of listing, the stock goes through wild price swings. The volatility at the HT Media counter which made its debut on the bourses on Thursday last week is a clear indication of this trend.

The stock which was issued at a price of Rs 530, opened at Rs 685 and surged to an intra-day high of Rs 731 before closing at Rs 557. A total of 199 lakh shares were traded, significantly more than the 76.9 lakh shares issued in the public issue.

How does one maximise gains from an IPO if the idea is to make a quick buck? Here are a few things you should keep track of.

1. Investors would do well to remember that stocks which are overpriced to begin with may attract short sellers on listing. Conventional measures such as the price-earnings multiple - something one looks at while deciding whether or not to buy a share - should be an indication of whether the stock price is sustainable.

But then, it is not just the valuation. Like any other commodity, stock prices are also influenced by the forces of demand and supply which may in the short run deviate from the intrinsic worth of the stock.

2. If there is a huge demand for stocks - you can gauge the demand from the oversubscription numbers - investors who got lesser allocations than desired may go on a buying spree in the secondary markets the moment the stock lists. Earlier, subscription numbers were exaggerated because of unscrupulous bids put in by institutional bidders.

However, with the Securities and Exchange Board of India (Sebi) recently introducing upfront margin payment while placing bids, the subscription figures should be a decent indicator of genuine demand.

3. The third point is the level of leveraged positions. This is a significant factor that influences the stock price movement on Day 1. In other words, leveraged positions indicate proportion of investors who subscribed to the issue with borrowed money.

Since the interest meter keeps running, leveraged investors usually look to exit the stock and take home whatever they can in double quick time. There is no way of finding out what portion of an issue is funded through borrowed capital. All you need to do is to follow news papers and talk to your stock broker.

This is how it works. Assume that an investor avails of 100 per cent borrowing to apply for share of ABC company priced at Rs 500. At an interest rate of 12 per cent, if the investor borrows for one and a half month, which is the case usually, the interest cost would be Rs 750. Now if the issue is oversubscribed 10 times, it would mean that every investor would get only one-tenth of what he applied for.

So instead of 100 shares, the investor is allotted only 10 shares. Dividing the interest cost of Rs 750 by the number of shares allotted, the cost that has to be recovered per share is Rs 75.

The investor would make money only when the share prices goes beyond Rs 575. So Rs 575 is an important threshold level beyond which leveraged investors would look to sell.

Usually shares open high and head higher as leveraged investors try to artificially push up demand in an attempt to get 'decent' exits, and the stock finds its level based on genuine buying interest. If the stock breaches this threshold level, the fall can be precipitous.