The Trouble with Bubbles

It’s that time of the market again, when everyone and their barber is enthusiastically opening demat accounts. Bull markets have many side effects, including seducing people into thinking investing is as easy as looking at a PE ratio, but possibly the worst consequence is a spate of new IPOs that come out each time. You see, many promoters realize that this is the best season to sell out part of their stakes because prevailing investor sentiment means just about anything will be bought without question. No due diligence, no reading beyond “analyst opinions” and “brokerage recommendations” (I swear these guys will be bullish on anything)

Now, the promoter wants to maximize the benefit so he comes up with a price that is at a premium. The flood of buyers wanting to take advantage of the hype and listing gains push up the price. This continues till someone starts cashing out heavily, triggering a cascade effect in the opposite direction that often pushes prices below the IPO price. Alternatively, the share price tanks straight away. Think this can’t happen to a well known company? I present to you the example of Facebook. The stock fell as soon as it opened, and the share prices crashed more than 50% over the next couple of months

Facebook

That the stock eventually recovered is irrelevant. Many overpaid and paid the price. An intelligent investor would have waited till the frenzy died down, done his homework and figured out a reasonable price to say, most likely scooping it up in the months post the crash. Gordon Gekko may have said that greed was good, but he certainly did not mean combining it with asinine behavior akin to running full tilt to the edge of the cliff, thinking you can stop just before falling off.

Lemmings

Some will point to how they bought into the IPO of say ITC, Larsen & Toubro or Infosys, ignoring survivorship bias. If a business is worth investing in, you could buy it many years following the IPO and still make a killing. At-least by then, you have more data to make a more informed judgement about promoter track record and the economics of the business and industry, and have a better idea of how to judge intrinsic value. The base rates of IPOs are downright terrible. Nearly 60% of IPO investors in the past decade lost money. The odds are most certainly not in your favour. Those who don’t learn from history are doomed to repeat it.

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