Why investors should be cautious of India’s IPO boom

A year ago, if someone had predicted that Indian stock markets were heading towards their lifetime highs, most economists and brokers would have scoffed it off. But the unbelievable has happened and it has triggered euphoric optimism.

Between January 1 and March 2, nine Indian companies made their stock market debuts, garnering a total of $1.46 billion (Rs 10,950 crore). The funds raised via initial public offers during this period are the highest since the corresponding weeks in 2008, according to London-based financial market data provider Refinitiv.

“This is a significant increase compared to $6.3 million from seven IPOs during the same period last year,” Elaine Tan, senior analyst at Refinitiv, said.

The IPO avalanche has been triggered by a strong bull run in the Indian stock markets. In March 2020, Indian markets saw their worst-ever sell-off as the Covid-19 pandemic and the lockdowns that ensued severely dented economic activity. India’s benchmark indices, BSE’s 30-share Sensex and National Stock Exchange’s 50-share Nifty, touched their lifetime lows due to the massive selloff.

But as Covid-19 cases in India remained far lower than initial estimates and the government injected a stimulus into the economy, benchmark indices have been soaring to new highs.

Once the lockdowns began lifting in June, the pessimism turned into unbridled optimism to the extent that by the end of 2020, companies had raised $3.5 billion via IPOs, a 40% growth year-on-year. Despite concerns around pay cuts, job loss, and economic contraction, investors welcomed these IPOs with a cheer. For instance, the IPOs of biscuit and bakery company Mrs Bector, fast-food chain Burger King and government-owned Mazagon Dock Shipbuilders were all oversubscribed by more than 150 times the issue size.

While the host of IPOs has kept investors in good spirits, it has also led some to worry if the Indian stock markets are in a bubble and the valuations of most companies are extremely stretched.

Highly valued stocks

Most of the companies that have gone public since last year have not only seen stellar listing gains but have also continued to soar to new highs over the following days. For example, the share price of Gland Pharma, owned by China’s Fosun Pharma Industrial, has been hitting all-time highs since listing in November 2020, after making double-digit gains on listing day on November 11, 2020.

The stock is currently trading at a trailing price-to-equity ratio of 44 times. It means for every Re 1 of profit, investors are willing to pay Rs 44.

It is not just Gland Pharma. Even stocks like UTI Asset Management, which initially dropped below the issue price, are now starting to fire up.

As the euphoria peaks, investors are paying little attention to valuations.

For example, shares of paints manufacturer Indigo Paints zoomed 100% on the day it listed, giving it a valuation of 200 times its profit. In comparison, Asian Paints, which is its much larger rival, trades at 83 times PE.

After hitting the bourse on February 3, the shares of Indigo Paints closed at Rs 3,118.65, which was significantly above its issue price of Rs 1,488 to Rs 1,490. And currently, despite the corrections, it is still trading above its issue price by a huge margin.

Irritational exuberance

There are multiple reasons for the spike IPOs.

Firstly, in a bid to boost the economy, central banks and governments over the world have been pumping money into the economy, which is finding its way into the stock markets. Also, besides big institutional investors, recent months have seen a hoard of first-time retail investors entering the markets.

“As long as the broader market keeps doing well, interest rates remain low, investor enthusiasm remains and investors keep making listing gains on the last few issues, this situation can continue,” said Deepak Jasani, head of retail Research, HDFC securities. “It is difficult to forecast as to when will this situation reverse.”

Earlier in January, the Reserve Bank of India had also raised concerns about the stock markets’ historic boom. The RBI governor Shaktikanta Das had warned that there is a disconnect between Indian stock markets and the economy, which could pose a risk to the country’s financial stability.

However, it seems like investors and companies are not paying heed to the RBI’s warnings.

Even as worries over the valuations mount, the list of IPOs has continued to grow. “At least 14 IPOs are likely to hit the market by March, with cumulative proceeds of over $1.2 billion,” Tan said. Some of the top IPOs that are expected to happen this year are Kalyan Jewellers, Barbeque Nation Hospitality and Easy Trip Planners. A few startups such as Zomato, Delhivery and Policybazaar, are also expected to go IPO, Tan said.

But as more and more firms queue up to raise capital, investors, especially retail ones, need to be cautious. Once the euphoria dies down, there could be some pain in store for investors of some of these IPOs.

This article first appeared on Quartz.