Is IPO Risky? How to Make Trading Profits from FPOs?

Tue, Aug 7, 2018 4:01 AM on Exclusive, Experts Speak, IPO/FPO News, Latest, Recommended, Stock Market, Video Tutorials,

-By Sudarshan Kadariya, New York

Comments: Su.kadariya@gmail.com

For the investors' awareness purpose, we have included a reference of 2017 United States Initial Public Offerings (IPO) report which indicates that the year-end gains for IPOs from 2000 to 2016 are positive both for the first-day (of trading) gain at the stock exchange and the year-end gain. There are only 3 negative year-end losses for the year 2000, 2008, and 2011 but realized the first-day gain for each year at the trading floor.

In Financial Times newspaper article “Why investing in IPOs is very risky”, Meziane Lasfer, Professor of Finance, London had concluded in his article that "Overall, investing in IPOs is very risky". Also, he added, "individual investors should invest in IPOs only if they are risk lovers". The evidence of positive data from the US market and the conflicting opinions from the academician from the other market has suggested that there is no unanimous conclusion on the performance of IPOs in the stock markets around the world.

In Nepal, a study on IPO performance by Radhe Shyam Pradhan, Professor of Finance, and Kushal Shrestha indicated that the greater the firm size, higher would be the initial IPO returns. Similarly, the reputation of the issue manager, the increase in subscription rate, and the better market condition would lead to a higher IPO initial return.

It is a need for us to explore more about the IPO performance in Nepal. We encourage our stakeholders – practitioners, readers, researchers, students, and academics to conduct further analysis on IPO performances in NEPSE. The insights derived from the scientific studies will always be appreciated by the investment communities. The possible regulatory changes in the IPO environment will create some volatility compare to the historical IPO performances. Despite the popularity of all types of public offerings in the past, the coming IPOs might give us a different test of returns. Now, we are giving access to more and more novice investors and also welcoming more are more private businesses to launch their IPOs to make them raise their capital from the public. This environment has given us a clear room to think about the possible proactive roles from the regulators. In case, if we will have a weaker regulatory mechanism which we do not expect, it is certain that the investors by themselves should be critical while investing in IPOs in coming days.

However, the Further Public Offering (FPO) has become one of the popular ways to raise additional capital for the public companies in Nepal. We are not sure the short-term and the long-term pros and cons of the FPOs - with the handsome premium amount. We assume that it would have the impact on stockholders and to the companies themselves. The fact is that any mechanism to add current market prices of the stocks. We have a number of examples to support this statement in our market in the past.

Here, we analyze the performance of the FPO after the announcement of FPO open dates. By the Nepal Bank’s experience, it has given us some sense that all FPOs are not something that the investors warmly welcome and invest. But, in the most cases, the new investors prefer to grab the opportunities to take FPO positions with the discounted market price at their perspectives. Even though, there are premium levied on the stock prices, the stock market factor the all available information and try to make stock prices relevant to it intrinsic values. But, by reviewing the FPO price performances, we assume it gives us a possible short-term and/or long-term profit-making opportunities. We are going to discuss this in details about the timing of the entry and the exit in the FPO before and after the FPO announcement dates.

There are altogether 12 FPOs in the last two and half years in NEPSE and they opened to the public in a range of 7 trading days to 22 days. In general, most of the FPOs were opened for at around 10 trading days initially but lately, FPOs open days are now getting wider frame i.e. 18+ business days whereas NBL's FPO was extended for 22 days due to the under-subscription which is an unusual event in the Nepalese capital market. Our experience shows that raising the capital through IPOs and FPOs are mostly oversubscribed in Nepal.

The detailed past FPOs are presented below:

We analyze the FPO price behavior of pre-90 days and Post-90 days from the FPO open dates. Daily stock returns are calculated for a complete list of 12 FPOs issued in NEPSE. We have certain assumptions like excluding outliers (greater than 10% up and down movements) from the data. The measurement indicators in the graph are not scaled to the percentage point return, we are just trying to indicate the pattern to find the buying and selling opportunities for those stocks. If we identify the precise timing to buy and to sell stocks, we would make short-term trading profits or, we can hold longer to achieve the long-term investment returns.

In the graph below, t+ is post-FPO days and t- is pre-FPO days. The period of buying opportunities can be defined as the period in which FPO stock price get depressed due to the FPO news and its dilution effects on its stock prices. We consider buying FPO from the secondary market during this period i.e. the deep against t-21 day and the deep on t-12 day onwards. We assumed we will not take any trades during FPO open days i.e. T01 to T022. Then after, we will look at the selling opportunities post-FPO days i.e. any suitable days when the stock price move upwards within the period after t+6 day to t+48 day. In the aggregate level, the trend line (RED) indicates the upward movement to post-FPO days.

If we zoom in the specific period t-21 day to t+48 day, we can see a clear picture in which the trend line indicates a pattern with a positive movement towards the post-FPO days.

Further, we would like to present a graphical presentation of the above discussions. It will help us to understand when to buy and to sell FPOs to realize short-term trading profits.

We do not encourage readers/investors to take this as an investment advice, take this analysis for the understanding and discussion purpose only. For investing advice, please consult with your investment professionals.

The bottom line:

  • With certain assumptions, the FPO’ prices in NEPSE behave in a certain pattern
  • The pattern indicates that there could be some quick profit opportunities if the similar FPO stock price behavior persists for the future FPO
  • We could make trading profits by buying FPO at prior 21 days (max) from FPO open date and by selling them at any suitable time post-FPO close date - between the period of day 6th and the day 48th (max).

Sources:

https://corpgov.law.harvard.edu/wp-content/uploads/2017/05/5.png; https://www.ft.com/content/773d42b2-1d8f-11e4-8f0c-00144feabdc0; https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2793490