3.13 Strategies For Investments In The Primary Markets

INVESTMENT STRATEGIES : PRIMARY MARKETS

As you now, an application to a new issue is decided by a lottery. In general, the good issues are oversubscribed by several times, i.e for every one share offered by the company there are many applications. There are instances when issues have been oversubscribed by 1,000 times with small chances of getting allotment. While there is no apparent cost in applying to a new issue, the allotment process takes a few weeks (3-4 weeks), thus blocking your money for this period. On the other hand, primary issues if allotted, yield high returns. If a share for which the investor has paid Rs 10 quotes at Rs 20 on listing, it implies a return of 100 per cent in say three to four months or it can even be 300-400 per cent per annum.

Also, the risk of applying to new issues (if done selectively and intelligently) is small. Therefore, the critical aspect of applying to new issues lies in increasing the chances of allotment, which, in turn, improves the return. There are many investors who apply to new issues in a scientific manner to average a net return of around 40 per cent (risk-free) per annum. Therefore, these investors prefer to operate only in the primary markets. Now the question that arises is about how can a person make selective applications.

First of all, unless it is a company with very good promoters (like Tatas, Birlas, Ambanis or any similar well-known concern with a good reputation), application to new issues is essentially a short-term investment. This is because a new issue is made by new companies or existing companies wanting to set up a new plant. Therefore, the returns from the plant depend upon its future performance. Past experience shows that, in general, new plants face teething problems which take one to two years to stabilise after the commencement of production. Very often, the commencement of production is also delayed.

So, a share would take about two to three years on an average before it fetches a reasonable price commensurate with an earning potential of the company (as depicted in the prospectus). However, on listing, the share quotes at a good price due to the phenomenon of supply and demand. Thus, a share would yield Rs 20 to Rs 30 immediately or a price of say Rs 40 to Rs 60 after two years depending on the performance. In these circumstances, it may be better to encash Rs 20 today unless the promoters are known to have a very good track record. In this scenario, a thorough analysis of the issue may not be necessary.

It is enough to ascertain whether:

  • The promoters are genuine and have a reasonable track record.
  • The product proposed to be manufactured seems to be marketable.
  • The purpose for collecting the money is reasonable and genuine.
  • The premium asked for is reasonable.

If the answers are positive, the share is almost likely to be oversubscribed and the investor will get a reasonable, risk-free return.

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