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FINANCIAL CHRONICLE™ » EXPERT CHRONICLE™ » Why arent IPO's ever priced cheap?

Why arent IPO's ever priced cheap?

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optimistic

optimistic
Manager - Equity Analytics
Manager - Equity Analytics
I have always wondered why IPO's are priced very expensive and they are also equipped with high PE ratios (most of the time higher than the industry average) relative to their EPS.

lets talk about an hypothetical scenario

Suppose a plantation company wants to raise 1 billion rupees. The plantation sector PE is 5. And this particular company's EPS is 2. So a fair valuation to this share would be Rs. 10. Instead the company decides to offer 50 million shares at Rs. 20 a share. when it could have offered 100,000,000 shares at Rs. 10 .

this is what we see in most IPO's nowadays. they are asking people to pay a premium to buy their shares. why would they not offer 100 million shares at Rs. 10? Is it due to a liquidity problem? Or they dont want to give out a lot of money in dividends? there could be many reasons. But I dont have a clear cut answer to my question. Sorry if this sounds stupid. I'd appreciate your replies.



Last edited by optimistic on Wed Jun 29, 2011 5:12 pm; edited 1 time in total

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sanjeewa88

Post Wed Jun 29, 2011 5:06 pm by sanjeewa88

There is a problem of defining the PE ratio.

PE= Price per share/EPS

Basically it is worthwhile to have a lower PE. Because we can have a better return by investing under lower P/E than higher P/E.

But we should not forget this

* EPS is calculated using past data. ( Annual or quarter reports)

* But the share price shows the future expectation of the company' performance if market forces are regular.

Now you can understand it is little bit complex than first.

If price of a share is going up gradually it should good sign about company. At the same time EPS can be calculated regarding to "price hike time" in next period.

Ex. XYZ company has lost their valuable contract worth 50% of their total profit relevant for coming year .

Then what will happen? Price will come down soon. But current year's EPS does not change. (As it does not affect to current year profit)

Ultimate result is PE takes a lower value.

Now do you buy this share based on lower PE ratio?

So keep in mind higher PE is good at all. Also I should mention this is valid only if the market is following economic fundamentals.

However the over pricing of IPO is another problem.

xmart

Post Wed Jun 29, 2011 5:22 pm by xmart

well my friend,
everyone wants to get maximum for their shares at IPOs. they can do whatever the magics and valuation and unrealistic future earning growth to verify its price with support of promoters.

problem with IPOs is we don't have any tangible material to do our own analysis except their prospect. so we cannot say higher PE is a sign of higher future growth. other fact is, if future prospect is good for a particular company, people will decide PE and pay a premium to growth. but at IPOs the company decide the PE. then people should be more cautious when applying to IPOs.

to me, Right issues are better than Overpriced IPOs. because we can control familiar demon easier than unknown angel.

econ

Post Wed Jun 29, 2011 5:27 pm by econ

why do we subscribe those overpriced IPOs?? simple thing we can do is just ignore them.

avatar

Post Wed Jun 29, 2011 6:03 pm by invest-abc

@optimistic wrote:I have always wondered why IPO's are priced very expensive and they are also equipped with high PE ratios (most of the time higher than the industry average) relative to their EPS.

lets talk about an hypothetical scenario

Suppose a plantation company wants to raise 1 billion rupees. The plantation sector PE is 5. And this particular company's EPS is 2. So a fair valuation to this share would be Rs. 10. Instead the company decides to offer 50 million shares at Rs. 20 a share. when it could have offered 100,000,000 shares at Rs. 10 .

this is what we see in most IPO's nowadays. they are asking people to pay a premium to buy their shares. why would they not offer 100 million shares at Rs. 10? Is it due to a liquidity problem? Or they dont want to give out a lot of money in dividends? there could be many reasons. But I dont have a clear cut answer to my question. Sorry if this sounds stupid. I'd appreciate your replies.

Optimistic, to answer your question offering 100Mn shares @ Rs 10 & offering 50Mn shares @ Rs 20 is the same. It'll have the same impact on the valuation of the company.

avatar

Post Wed Jun 29, 2011 6:14 pm by Hiru

If issued 100mn instead of 50mn following things will happen.


1. Immediate dilution in ownership control
2. Subsequent dilution in EPS and DPS

This is for you information and not to disregard the point.

sanjeewa88

Post Wed Jun 29, 2011 6:33 pm by sanjeewa88

@xmart wrote:well my friend,
everyone wants to get maximum for their shares at IPOs. they can do whatever the magics and valuation and unrealistic future earning growth to verify its price with support of promoters.

problem with IPOs is we don't have any tangible material to do our own analysis except their prospect. so we cannot say higher PE is a sign of higher future growth. other fact is, if future prospect is good for a particular company, people will decide PE and pay a premium to growth. but at IPOs the company decide the PE. then people should be more cautious when applying to IPOs.

to me, Right issues are better than Overpriced IPOs. because we can control familiar demon easier than unknown angel.

Don't you feel the problem is with unrealistic pricing by companies?

If I'm correct most of the time IPOs are pricing based on some accounting bases rather than the market conditions. ( I may not correct at all, I felt it)

avatar

Post Wed Jun 29, 2011 6:50 pm by wis

@sanjeewa88 wrote:
* EPS is calculated using past data. ( Annual or quarter reports)

* But the share price shows the future expectation of the company'

Yes. We have to be careful with the low PE numbers of the shares. Almost all low PE ratios are because they sold something big in the last 4 quarters. Most companies will have a hard time keeping up with the past earnings in the next quarters.

optimistic

Post Wed Jun 29, 2011 7:20 pm by optimistic

thank you all for the contribution. reps to all. from whether the IPO asking price denotes a low or a high PE ratio, it may not be correct to determine the credibility of a company. and like xmart said, tangible results could be a fact that could determine if an IPO is worth subscribing for. even that, only if the company presents to us a true and a fair view of the past performance. however optimistic they maybe about the company's performance, there's is no 100% guarantee that they could achieve their targets for them to prove to investor's why their asking price is a premium to the market. i would avoid over priced IPO's. my general stand on IPO is that it is a waste of time and it is only sucking the much needed liquidity from the secondary market.

Slstock

Post Sat Jul 02, 2011 6:32 am by Slstock

@optimistic wrote:thank you all for the contribution. reps to all. from whether the IPO asking price denotes a low or a high PE ratio, it may not be correct to determine the credibility of a company. and like xmart said, tangible results could be a fact that could determine if an IPO is worth subscribing for. even that, only if the company presents to us a true and a fair view of the past performance. however optimistic they maybe about the company's performance, there's is no 100% guarantee that they could achieve their targets for them to prove to investor's why their asking price is a premium to the market. i would avoid over priced IPO's. my general stand on IPO is that it is a waste of time and it is only sucking the much needed liquidity from the secondary market.

Yes , most recent IPO seems to be overvalued. When I determine whether an IPO is a good investment, I look at both NAV and PE value along with their financials documents, growth prospects and Management team. For Long term going solely on one aspect itself might not be enough if not considering the growth factor. There are different kind of shares. Value and Growth ( which people may pay a premium) for example.

Short term profit mind set and long term investment mind set might differ . For short term it is definitely better to calculate PE against it sector, market and prevailing trends, consider it NAV, IPO share numbers before making an entry. This is not the time blindly pick IPo like some years ago where IPo was not a common sight.

avatar

Post Sat Jul 09, 2011 3:23 pm by lokuayya

We should collectively avoid overpriced ipos .if P/E is higher than 10 for any sector we should avoid.

avatar

Post Sat Jul 09, 2011 5:15 pm by lokuayya

I am telling this because IPos should come at a good discount or at a fair price .Now it has become a practice to issue private placement very cheaply and go to IPos with a higher price.Only buddies of the company bosses can take profit while IPo subscribers take only losses.If the private placement price is very much less than the IPO price ,the lock in period for the private placement shares should be extended to five years.

avatar

Post Thu Jul 14, 2011 10:09 am by Quibit

Print Edition
Investors have lost faith in IPOs
THURSDAY, 14 JULY 2011 00:00
By Keishara Perera

Most of the investors have now lost trust in present Initial Public Offerings (IPOs), and will be extra cautious when investing in future IPOs, capital market stakeholders told Mirror Business.

They are of the view that a large percentage of discounts offered at Private Placements has discouraged public investments and brought down the confidence in the entire system.

Ravi Abeysuriya, CEO Herayamila Securities said, he had been very critical about private placements from the begining.

“One has to be very careful in investing in IPOs, and it is advisable that they obtain professional advice when doing so,” he stressed.

Abeysuriya said that people will invest based on their risk taking ability, and they may even avoid IPOs, as there are several other investment options.

“I’m pretty sure investors would have learned their lessons by now, and will not be rushing in to buy stocks without analyzing all the risks involved,” Abeysuriya added. “I also feel that there will not be much money flooding in as in previous IPOs such as the Union Bank IPO which was oversubscribed by record number of times.”

Meanwhile Hijaz Suhair, Asst. Manager Corporate Advisory and Capital Markets, Merchant Bank of Sri Lanka said, Private Placements have had a bad influence on both the Expolanka and Softlogic IPOs.

“Expolanka had the potential, but I guess the market didn’t see it because of the very low price in Private Placements with huge discounts. That’s why it didn’t stay above the IPO price,” he explained.

Suhair went on to say that companies need to look in the valuation of stocks and make sure they are not overpriced at IPOs. “Softlogic was a little overpriced IPO, where private holders wanted to sell at a lower price than the IPO price,” he noted.

According to Suhair, recommendations about stocks should be made more responsibly and merely saying “a good buy” to each and every IPO is not what should be done.

Good lesson for

companies – Regulator

What is happening in the Colombo bourse at the moment will be a good lesson for companies planning Initial Public Offerings in the future, a top Securities and Exchange Commission (SEC) official told Mirror Business.

“This definitely is a good lesson for the companies who will be coming into the market. It will prevent them over-pricing their share issues. Although IPOs are getting aMeanwhile Suhair said that future Private Placements are going to be highly unpopular and companies should be looking to create more value after the IPOs. “IPOs need to give value to the public and there should be discounts towards the public in order to encourage more public investment,” he stressed. “Else, people who invest with little knowledge will never turn to stocks again, if the experience was bitter,” Suhair added.

Speaking to Mirror Business on the same issue, Channa De Silva, CEO, LR Global Fund said, if there is no place for investors to benefit, they will stay away from the stock market. “Even in the case of a good IPO, investors will do the same. When a stock falls below the IPO price, investors tend to remember it for a long time.”

“What I feel now is that investors will not be rushing for IPOs, and instead they will be very cautious. The sudden urge for IPOs will simmer down for the next 6 months and there will not be a huge hype as there was in the recent past,” De Silva said.

However he went on to say that volatility is part and parcel of the stock market, and if investors trust the share, they should hold on to it, since the stock may rise provided  the companies are strong. “Don’t rush to sell, just because the stock has fallen below the IPO price on the first day. Company stocks have the ability to emerge again,” he emphasized.

avatar

Post Sun Jul 17, 2011 8:22 pm by dilshanusjp

can u explain me what should be the exit price of SHL/still i retain all the shares without selling.

avatar

Post Sun Jul 17, 2011 8:46 pm by Aamiable

@lokuayya wrote:I am telling this because IPos should come at a good discount or at a fair price .Now it has become a practice to issue private placement very cheaply and go to IPos with a higher price.Only buddies of the company bosses can take profit while IPo subscribers take only losses.If the private placement price is very much less than the IPO price ,the lock in period for the private placement shares should be extended to five years.




Prices come down and rallies start,… if there are credit rallies then what happens

Cool

econ

Post Mon Jul 18, 2011 4:41 am by econ

why not we have fairly priced IPOs,
For example, browns investment IPO is priced 4.7 PE ratio. it will list in diversified sector or investment trust sector where PER over 25.

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