March 25, 2019 (MLN): An investor’s world is often influenced by sentiments which leads to performance changing behavior. Investors who switch between stocks in search of superior returns often forget that returns that look attractive in the short term often go through a mean reversion over the long term.

So far, last few years have been depressing for IPO investors. Investors should take the heed when they get excited about an upcoming initial public offering.

IPOs are a risky investment as it is tough to predict what the share will do on the trading day as well as in near future. This is because there is no substantial historical data to analyze the company’s standing. In addition to that, the companies up for an IPO undergo a transitory growth period which is subjected to uncertainty for future values.

If we look into the historic data, Pakistan’s IPO market performed poorly and the returns for the initial investors turned out to be negative.

During 2015 to 2018, fifteen companies filed for Initial Public Offerings other than Modarabas, out of which eight companies performed well on their first trading day as their initial returns to investors were positive.

However, after adjusting these figures against the market returns, it turns out that only six companies out of fifteen displayed positive market adjusted initial returns.

History tells us that most of the companies come out in IPOs during the bull markets when prices are high and irrational investors are willing to pay any price for owing stocks. The greed and overconfidence of the investors is so strong during bull’s market that they are willing to buy anything at any price.

This further leads to some unscrupulous managements to come out with IPOs to cash in on the current IPO boom and take advantage of investor’s greed.

This is due to the fact that if investors have made money in a couple of IPOs, then other IPOs that may not be of good quality will become representative of profitable IPOs.

Investors blindly chase IPOs. This herd mentality creates huge demand and the IPOs tend to get over subscribed. This demand-supply mismatch may create profit for the investors on listing due to the prevalent market conditions. But as the listing euphoria dies down, so do the prices of many of these IPOs.

Moreover, the IPOs in the last two years have displayed mixed narration, with three of the six outperforming the KSE-100, while the other three massively underperforming.

In an IPO market, the small investors generally get trapped in the words of their brokers, as they are lured into the hype and often end up betting larger part of their savings on listing gains.

The manipulation involved in the entire process of book building itself is highly criticized, as these deceits have led to investors suffering huge losses.

As mentioned earlier, the market for IPOs in Pakistan is limited as only fifteen companies (other than Modarabas) came up for listing during 2015-2018. But as the Central Bank is tightening the monetary policy, private companies may again return to the capital market which at the moment has great appetite for fresh IPOs in contrast to a low interest rate environment where corporates tend to turn to banks for finance at minimal interest rates.

A safer route may be to wait for a company to go public but to be selective about which IPOs to participate in. The most reliable indicator of whether a given IPO will be a good long-run investment is whether the pre-IPO annual sales were higher or lower than the threshold level.

While on one hand there are chances that IPOs can reap immense benefits for the investors, on the other hand there are too many IPOs that can get trap investors and lead to massive losses.

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