It was a wintry morning, and I was reluctant to wake up. The temperature had fallen below the tolerance level of my body. Suddenly, my phone rang. "Hey, did you apply for the IPO of Chandragiri Hills? The issue is closing today," said my friend excitedly. "Oh really!" I answered.
Financial literacy is necessary for the IPO hungry investors. If not, sooner or later, a bad decision may transform the overwhelming enthusiasm among the investors into severe depression. This may discourage investors from taking part in the capital formation process, which, ultimately, will scuttle the dream of creating a prosperous nation
Then he added, "Don't miss the opportunity to double your money in a couple of months."
My friend is just an example of the countless opportunity hungry investors desperate to double their money. In a sense, the rising IPO cult is a boon for an economy like ours in the aftermath of the much hyped Nepal Investment Summit 2019, which could not attract the expected foreign direct investment.
Nevertheless, the level of awareness among the investors about the risks associated with doubling the amount of the initial public offerings (IPOs) is a matter of concern.
In his widely acclaimed book "The Intelligent Investor", value investing pioneer Benjamin Graham has defined investment as "an operation which upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
Are the IPO hungry investors doing some financial analysis before putting their hard-earned cash into such issues? If not, how do they ensure the safety of their investment, let alone the target to double the investment? A plethora of investors make investment decisions solely based on the hoaxes rampant in the market. Many of them do not even go through the financial statements.
Buying stocks is not merely buying a piece of paper, instead it is buying a piece of business. The value of stock goes up or down depending upon the potential of the business to increase revenue and profits except under certain circumstances.
Therefore, an investor in an IPO must have longterm horizon and patience to harvest handsome returns.
If you invest in an IPO expecting return from speculative growth of the stock price instead of real business growth, then the bubble may burst any time, causing you tremendous loss. As Berkshire Hathaway CEO Warren Buffet said in one of his famous sayings: "Rule number 1: Never lose money. Rule number 2: Never forget rule number 1".
Prior to getting into an investment decision, it is imperative to understand the business model of a company that you want to invest in. If the business model is too complicated to understand, then it is certainly not going to work for you. In most of the cases, if it seems too good to be true, it probably is.
In addition, an investor must consider the business-related and market-related risks associated with an investment. It is comparatively less risky to invest in companies where the management team is acquainted with the nitty-gritty of the business they are in.
In general, a company goes to the public when it is more favourable to the company than to the investors, like when it is venturing into new areas, expanding the existing facility or reducing the debt. So, an investor must be cautious about the vested interest of a company going to the public.
In the context of Nepal Stock Exchange, the market movement is largely influenced by rumours disseminated relentlessly. In most of the cases, such gossips are attributed to the transition of the finance minister or government. By and large political stunts play a prominent role.
Such news is unnerving to amateur investors implied to believe the market is in decline solely as a ramification of the political chaos. As a result, the NEPSE index plummets suddenly. On the other hand, if a finance minister or government who is trusted to be capital market-friendly takes the reins, then the market is blessed with incredible optimism.
These are often the driving forces behind the so-called "bearish and bullish trends" in the Nepali share market.
To double the money invested in an IPO within a couple of months, there must be someone willing to pay that price. Why would someone pay twice the amount paid for a stock just one or two months earlier? In such a case, investors are just betting on speculative growth, which can backfire at any time. As Graham proclaimed: "IPOs not always mean Immediate Profits Only" it can rather turn out to be "Idiotic, Preposterous and Outrageous" as well.
Financial analysis is the cornerstone behind an investment decision. Even a layman investor must reckon the financial health of a company to ensure the safety of the investment.
Thankfully, these calculations do not require advanced math skills. The only thing needed is knowledge of basic arithmetic and algebra, which are taught in school. The most used metrics to make an investment decision includes, but not limited to, intrinsic value, price to earnings (P/E) ratio, price to book (P/B) ratio, earning per share (EPS), net asset value per share (NAVPS) and so on.
Above all, it requires incredible optimism and patience to book a hefty profit.
As prominent American investor Charlie Munger affirmed:"Stock investment is like swimming in the sea, sometimes the tides are along with you and sometimes against, the only thing you have to do is to keep on swimming."
In a nutshell, financial literacy is necessary for the IPO hungry investors. If not, sooner or later, a bad decision may transform the overwhelming enthusiasm among the investors into severe depression. This may discourage investors from taking part in the capital formation process, which, ultimately, will scuttle the dream of creating a prosperous nation.
Arguably, it is comparatively safer for naive investors to invest in less risky financial instruments, like mutual funds run by seasoned fund managers, index funds and in government and corporate bonds. Otherwise, the investment journey may be like riding a tiger, not knowing how to get off without being eaten.
A version of this article appears in the print on February 26, 2021, of The Himalayan Times.