SMART INVESTING IN IPOs

We have an upcoming IPO in a few months in the Nairobi stock exchange and we have had a history of where we rush to buy with the hope of cashing in on good profits quickly then the share plummets then sell it right at the bottom to smart money, case in example, Safaricom shares. Actually in all the IPOs I tracked before I wrote this including Facebook, the shares fell in value a short while after listing some even immediately after, making the odds of you making money in the short-term after buying stacked against you. Some like Trans-century have continued to trade below listing price for a period of time. To some extent, it has created negative publicity like in the case of Eveready where there were investors who borrowed heavily to buy the share. But why do shares fall after IPO? I will offer a list of possible explanations.

First of all, due to the hype usually surrounding IPOs, there has always been the assumption that investing in them gets you on the ground floor before everyone else, but in actual sense when you are investing, the share is usually on something like the 6-12th floor depending on the pricing of the share by the underwriter. By the time you are buying it from your broker, other parties usually have bought it much earlier through about 3-4 rounds of investments way below the price that is offered at the exchange, after all, investors deserve a reward for the risk of buying it before it listed. The commission that the underwriters get is also a function of the IPO plus at times IPOs usually offer an incentive for the initial investors to list as they can sell it at a premium.
Secondly underwriters often make officials and employees of the company to sign binding contracts not to sell the shares until expiry of a certain period of time which can vary from months to years in order to retain confidence in the company. When the period expires insiders try to sell their shares to realize profits at a premium to the price that they bought it at before listing. This results in oversupply in the market, couple that with panic selling due to lack of information with regards to the company financial performance and you have decent sell offs like what happened to Home Afrika where we saw an investor offloading a decent sized block of shares from around shs.6.

How can you make money from it? Before you buy it, it’s advisable to check the company financial information and valuation. If you think the valuation is good and they are likely to continue making profit then you can buy it and wait. Also find out what they intend to use the money they raise from the listing for. The second option is to buy it then flip the position immediately after the initial rally that usually occurs on the first day of listing. Institutions often do this and they make a lot of money from it, it’s flipping that in most circumstances causes the share to drop after listing. Brokers discourage this as they prefer buyers to hold onto the share. The third option is to buy it a year after listing when they have released financial information and when the share in most circumstances is usually trading at discounted prices.

Mathematically the odds are against you making money from an IPO. In fact if the company is weak (there is usually less information to validate this), then you might be as well be investing a Ponzi since the share will be relatively cheaper in a year for a better bargain. In case you get caught up in the buying euphoria, don’t panic, evaluate the company and if they meet your conditions of it being a good buy, then add more but if they don’t or don’t have evidence to substantiate, I would think you are better off diversifying into other favorable stocks to mitigate potential losses. Just don’t fall blindly for the publicity they generate, underwriters are essentially salesmen, it’s beneficial for them if the share gets plenty of buying interest. Good luck investing in the IPOs as we look forward to now about three companies planning to list, one in insurance, another in mining and then the NSE itself.