With bellwether stocks riding the crest of a rollercoaster, retail investors have started fishing for lesser-known stocks that haven’t been touched by the rally yet.
They are also sniffing for money-making opportunities in the primary market — or new issues. That side of the market has been in the doldrums since the mid-nineties and retail investors haven’t forgotten the robber barons who issued stocks in the first flush of liberalisation of the economy and then disappeared with the loot never to be seen or heard of again.
In 1994-95, as much as Rs 13,312 crore was raised through public issues, but many of those companies that issued shares are today untraceable.
Singed investors fled in hordes, and the primary market remained depressed for years. But at long last, it is showing signs of revival. According to Prime Database — a research agency that tracks the primary market — there are as many as 100 IPOs in the pipeline.
The renewed interest in new issues probably stems from the fact that investors have made decent profits from nearly all the recent IPOs. But alongside quality IPOs, there are a few dubious ones that have sneaked in as well despite the eagle-eyed scrutiny in a tight regulatory regime.
The mid- and small-cap segments are also fraught with pitfalls. Of late, the mid-caps have outpaced the heavyweights in growth. Such is the thirst for new investment ideas that shares of even defunct firms have rappelled up in the rally.
Consider Daewoo Motors. From an all-time low of Rs 1.20 that it hit on April 30, the stock rose to Rs 9.98 on November 11, though the company remains closed. Such aberrations can cost you dearly.
So what should you consider before investing in an IPO or a mid-cap stock'
“Remember Enron' Or the rally in technology shares in 1999-00' Do not invest in a stock if you're not sure about the management or its promoters," says Ajit Day, a veteran stockbroker.
Recently, promoters of a leading retail chain sold a part of their holding in the market, before issuing shares to themselves on preferential basis at a discount to the price at which they had parted with their shares. Should you the buy shares of this company'
Analysts and credible stockbroker should be able to advise you on the quality of a company's management if its shares are listed. But how do you form an opinion about the management of a company that has yet to debut on bourses'
“Investment banks play a very big role in IPOs — it’s their credentials that many would go by. The big ones do not back bad issues. There are certainly some exceptions. Nevertheless, you should consider the credentials of the investment banks endorsing an issue,” says Day.
What you should consider next is the growth potential of the company. For a fair assessment, compare its past performance with its peers. Also consider the outlook for the industry in which it operates.
Once you are sure about the management and the growth potential of the company, you should turn to some basic financial ratios.
“A retail investor need not go beyond the price-earning (P/E) and price-to-book value ratios. These are simple arithmetical tools to measure the share price in respect to the company's performance and assets,” says Rasesh Vasa, vice-president of Kotak Mahindra Capital Company.
You derive the P/E ratio by dividing the market/issue price by the company's earning per share (EPS). If a company is trading at Rs 100, and its EPS in the last financial year was Rs 10, it is trading at a P/E multiple of 10. To put a stock's valuation in perspective, compare its P/E with peers. The 30 sensex stocks are trading at an average P/E of 15.67.
The book value of a stock indicates the asset base of the company. Though it tells you what you are paying for and a low price-to-book value ratio can, at times, build confidence, the ratio is losing significance as more companies (even the ones in the business of manufacturing) are looking to be asset-light.
Investors feel a bit more confident if the issue price is determined through 'book-building' wherein institutions determine the fair valuation of the stock through bidding, says Vasa.
Calculating the dividend yield of a stock could reveal undervalued situations. For instance, if a stock is trading at Rs 40, and it pays a dividend of Rs 4, the yield works out to 10 per cent, which is better than other assets.
Another factor that is attracting attention is foreign institutional appetite. Foreign funds have pumped in $6 billion this year, and are one of the biggest movers of the equity market.
Stocks in which foreign institutions have an interest tend to run up fast, but they are also more volatile. Consider Maruti. In less than three months, foreign investors have nearly doubled their stake in the company, and the stock had run past Rs 350. In hindsight, Maruti's looks a steal at Rs 125 (its issue price).
Tread the primary market with caution. There's certainly money to be made in IPOs and mid-cap stocks, but the chances of burning your fingers are much greater when you are looking for opportunities in the realm of the unknown.