India’s primary market — where companies raise fresh capital by listing their shares for the first time — has witnessed extraordinary activity in recent years. The pipeline of companies seeking to access public capital has been robust across sectors, and investor enthusiasm for initial public offerings has at times reached fever pitch. In this environment, it is worth stepping back to understand how the primary market connects to the secondary market where the INDEXBOM: SENSEX and the Nifty 50 capture the performance of already-listed companies, and what this means for investors who participate in both.
The IPO Boom and What Drives It
When equity markets are buoyant and valuations high, the window for companies to list opens up very attractively. Founders and early investors can get higher valuations for their businesses, and the overall enthusiasm of retail and institutional investors means subscription levels are strong. This sets off a virtuous circle of successful listings attracting more companies to the primary market.
The democratisation of IPO investing via apps has brought in millions of new first-time investors to the primary market. The frictionless onboarding of applying to an IPO via a UPI-linked account with a tap has enabled a lot of participation. Good for the markets, but also a lot of people who come in purely to profit from short-term listing gains.
Institutional investors play a big role in the price discovery of any IPO, and their participation (qualified institutional buyers’ portion) and anchor investor allotments before the retail subscription opens up is a good barometer of what sophisticated investors think of the business. A good anchor book is not necessarily a guarantee of upside on listing, but is a good sign to take note of.
From Listing to Index Inclusion: The Journey of a New Stock
After a company has listed and started to trade on the secondary market, it goes on to the next stage that determines its future trajectory. To get into one of the indices in future requires satisfying certain criteria such as market cap, liquidity and listing history. Inclusion in the index means the stock gets a permanent allocation in all the passive funds tracking that index — this creates automatic buying demand in the markets.
The announcement of index inclusion can trigger a jump in the stock price as index funds and ETFs buy the stock to add to their baskets ahead of the effective date of inclusion, which drives the price up temporarily and then settles. An investor who buys in ahead of this technical demand, and sells on the day of inclusion to lock in the gains can benefit from this technicality, but the play has gotten very competitive as the mechanics have become well known.
Long-Term Holding Versus Listing-Day Trading
The bifurcation of IPO investor behavior is interesting. While people apply to IPOs with different motives, the listing-day liquidity provides a set of opportunities for traders.
As the shares get allotted and start to trade on the listing date, the sellers are most likely to be the short term applicants booking their gains, and the buyers could potentially be long term investors who missed out on the IPO allotment and want to start off a position, or institutional investors building their positions incrementally.
For those looking to hold on to their shares beyond the listing date, the question becomes whether the business represents an attractive opportunity at the valuation it is trading at post-listing.
Many fantastic businesses that have listed in India have seen their stock prices multiply many times over in 5-10 years for investors who stuck around through the initial phase of price discovery and volatility around the listing window.
Evaluating Offer Documents Before Committing Capital
The draft red herring prospectus and final offer document filed with the regulator contain all the pertinent information on the company, its business, financials, risks and the use of proceeds from the offering. Most retail investors miss out on this document entirely and rely on what they read in the media, broker notes or word of mouth to make a judgment on the IPO, which is a huge disservice to themselves as investors.
The risk factors section of the offer document is an enormous goldmine of information on what the company itself thinks are the possible threats to the business, ranging from regulatory issues and key person risk to competition and potential litigation. It doesn’t mean you should run away from an IPO if some of these risks apply, but it definitely helps to understand what the company is up against as an investor.
The financials included in the offer document, typically spanning 3-5 years of audited history, can help provide context around the trends in revenue growth, evolution of margins, working capital needs and capital allocation discipline of the company. A company witnessing rapid growth in revenues, but with deteriorating margins and cash conversion, needs to be looked at closely, even if the investor is tempted to jump on the growth bandwagon.