24 May 2016

Interview with John Huber - Part 1


John Huber Basehit Investing

John Huber is portfolio manager at Saber Capital Management and author of the popular investing blog Base Hit Investing. In his own words, his investment style (which is amazingly methodical) is influenced by Warren Buffett, Ben Graham, Walter Schloss and Joel Greenblatt.

I have become a big fan of his writing and thought process, ever since I came across his blog and strongly recommend it to anyone interested in following a structured approach towards investing and improving as a rational thinker.

I thank John for agreeing to get interviewed for Stable Investor.

So lets get straight to the interview now…


Dev: Hi John. Tell me something about your investment journey. How did you get to where you are?

John: I’ve always loved investing. My father was an engineer by trade, but was very active in the stock market (investing his savings) and by extension, I became interested in stocks.

But I came to the world of investment management unconventionally. I began my career in real estate, and I established a few small partnerships with family members and friends to begin buying undervalued income producing property. We bought residential properties as well as small multi-family properties.

About ten years ago, I began studying the work of Warren Buffett. Like many value investors, the simple logic of value investing really resonated with me right from the start.

I began studying Buffett’s letters, and reading various Buffett biographies. I set a goal early on to establish a partnership that was similar to the partnership Buffett set up in his early days.

After a number of years, I was fortunate to build up enough capital to support my living expenses while also seeding my investment firm. Saber Capital Management was established in 2013 as a way for outside investors to invest alongside me. Saber runs separate managed accounts, so clients get the transparency and liquidity of their own brokerage account. Our goal is to compound capital over the long run by making concentrated investments in well-managed, high quality businesses at attractive prices.


Dev: I know you focus a lot on having a process-oriented approach towards investing. How should one go about creating and refining one’s investment process?

John: It’s a great question. I think developing an investment philosophy is very important.

There are many different investment approaches out there — even within the value investing category. I think it’s important to first identify an investment program that will work (value investing — or buying stocks for less than what they are worth) works over time.

But I also think it’s important to understand your own personality, your own skill sets, and your own circle of competence.

Look at Benjamin Graham and Charlie Munger as an example. An approach that worked for Ben Graham was a completely different approach that ended up working for Charlie Munger, yet both were fantastically successful. But they both had different skill sets and preferences.

Graham loved numbers, he loved the mathematical aspect of investing. He thought of a portfolio like an underwriter would think of the insurance business—buying stocks for less than their net asset values worked collectively as a group over time, but any one individual situation was difficult to predict (just like insuring 1000 automobile policies with a given set of underwriting criteria would lead to very predictable results—although on a case by case basis it would be very difficult to predict which driver would end up making claims). So Graham’s preference for these investment tenets led him to manage a diversified portfolio of value stocks.

On the other hand, Charlie Munger became fascinated by great businesses. He wanted to own companies that could compound at high rates of return over long periods of time. He loved thinking about the intangible qualities of great businesses.

He once asked an associate to write up an investment thesis on Allergan, and when the associate came back with a list of Graham-esque metrics, Munger told him to forget the numbers and research why the company had such an advantage over its competition.

He was interested in brands, pricing power, predictability of earnings, high returns on capital — things that produced growth and compounding value over time.

Both Graham and Munger were enormously successful in their partnerships—both producing around 20% annually over the period they managed money, but both did so in very different ways.

Neither were right or wrong in their approach, but both managed money according to their personalities.

I think if you first identify what works in investing, and then you tailor it to what you like and what you understand, you’ll do well over time.

Along with value principles, discipline, and patience, perhaps Polonius has some good words of advice when it comes to setting up an investment process when he told his son Laertes in Hamlet: “To thine own self be true”.


Dev: How to generate new investment ideas and more importantly, how to filter those Ideas?

John: I used to do a lot of screens and other mechanical methods to generate ideas, but I find the best way to look for good investments is just to read as much as possible, build watchlists of good companies that you feel you can understand, and then patiently wait for opportunities to buy stocks on that watchlist. Inevitably, if you have a list of 50 or so businesses, there are almost always opportunities on at least a few of them to make an attractive purchase of an undervalued stock.

So most of my time is spent reading about companies and trying to always increase my understanding of the companies I follow, while also slowly expanding my circle of competence.

I read a lot of company annual reports, but I have also found a lot of value reading books about businesses, or books about general industries. I also read numerous newspapers, and the Economist.

Often, investment ideas come from situations that occur within companies on my watchlist that I already know well. Other times I read about a special situation or corporate event in the news that might offer an interesting investment idea.

So while my method isn’t scientific, my routine is quite replicable, and it basically involves a lot of reading and thinking. I would say that it is an approach that helps me always be tuned in to a variety of interesting situations where opportunities often pop up. But most importantly, it’s an approach that helps me continually learn, and I enjoy that aspect of investing.


Dev: Do you believe in importance of having an investment checklist?

John: I do think having a checklist can be a very valuable exercise. I’ve discussed checklist items before, but I’ve also adapted this point of view in recent years as well.

While I consider various checklist items when evaluating a business, I have found that because each investment situation is so different, that unlike flying an airplane that requires the same multi-point checklist before each flight, each investment is like a snowflake—it is unique and not exactly like any other investment.

So while I’m 100% sure that studying case studies is a valuable exercise (especially investment failures of great investors — something Mohnish Pabrai discusses which is a great idea), I’m not sure that a single checklist will be suitable for each investment idea. 

Studying why Dexter Shoe was a bad investment is a very valuable exercise. But the lessons learned from that case study might not transfer directly to another investment situation with its own unique set of variables.

So I don’t have a practice of running a bullet point mechanical checklist, although I think that might work for other investors and it’s certainly not a bad idea.

Instead, I choose to try and locate investments with very few variables that are required for the investment to be a success. I try to identify those variables, and then evaluate them over time as the investment plays out.

I think studying case studies probably helps you build a mental database of checklist items, so maybe indirectly we all have checklists as investors, but I choose to focus on each individual investment as its own situation with its own set of variables, and I try to reduce risk as much as possible by locating ideas with very things that can go wrong. The lower the hurdle, the better I like it.

Note - John has agreed to share a checklist which he prepared few years back. Below is the snapshot of the checklist. Though he doesn't strictly follow the checklist approach anymore (as discussed above too), it can still be a great starting point for those who are setting out to build their own checklists. You can read about it in detail here.




Dev: It’s very easy to say that investors should only invest when value on offer is blindingly more than the price that needs to be paid. But how does one implement that in reality? Being greedy when others are not, is actually quite difficult to do.

John: As I said before, each individual investment is different, so there isn’t necessarily an exact approach that can be implemented with each stock being evaluated.

But I think the first thing is to stick to businesses that you can understand. This is widely discussed, and highly touted, but I think it still might actually be under-appreciated. 

Reducing unforced errors in investing goes a long way to producing great results over time. And reducing mistakes comes from sticking to what you know, and picking your spots.

I think patience is a real virtue in investing, and over the course of time, there will be a number of opportunities to buy good businesses at prices that are clearly well below their intrinsic value. The key is to have a list of companies you know very well, and then just wait for one of them to fall significantly below your range of estimated values. Easier said than done, but being patient is very key.

It is also a necessity in investing to have a calm demeanor and a contrarian attitude in general — the market is often correct, so being a contrarian for contrarian’s sake alone isn’t rational, but you must be able to be detached from the crowd so that in times of general market panic, you are willing to buy stocks even when the near term outlook is bleak. This is also easier said than done, but it helps if you have a long-term view of stocks, and stick to owning good businesses that you understand well.

One other thing to point out—I’ve read the average NYSE stock fluctuates by 80% annually (meaning the 52 week high is 80% above the 52 week low for the average NYSE stock). This holds true across every index, and every country (probably much more pronounced in many countries than it is in the US).

Note - Check out a similar analysis on Indian markets here.

So stock prices are very volatile. There is no way that the average company’s intrinsic value fluctuates this much on an annual basis.

So this of course means that stock prices fluctuate much more dramatically than true values do, giving investors an opportunity.

And since these statistics refer to annual levels, it means that there are a lot of opportunities each year in the stock market to buy undervalued merchandise.


Dev: Joel Greenblatt (of Magic Formula fame) once said, "My largest positions are not the ones I think I'm going to make the most money from. My largest positions are the ones I don't think I'm going to lose money in." What are your thoughts on this?

John: I completely agree with this. In fact, my largest position right now is Berkshire Hathaway, which became my largest position in February (I wrote a post recently outlining my thoughts on Berkshire).

The stock doesn’t have tremendous upside as its capital base is so large now, but it has—in my opinion—virtually no chance of any permanent downside.

These are my very favorite investment ideas because they allow you to put a lot of capital to work with no risk, and I’ve found that often the market “corrects” itself sooner, meaning that sometimes 2 or 3 year return potentials occur in a year or less, simply because of general market volatility.


1) Don’t lose money.

2) Don’t forget rule number 1.

Trying to stick to companies you understand and sticking to businesses that are growing value over time helps reduce risk.

I think keeping a relentless focus on capital preservation is the best way to produce great results over time.


Dev: Another of Greenblatt’s idea has been to focus on the Key Variables of an Investment. He mentioned once that he might be average when it comes to the valuation exercise. But was above average at putting the information in context, remembering the big picture, and being able to pinpoint what factors really matter to an investment. How does an investor focus on what really matters?

John: I agree with Joel on this point as well. I think many investors get lost in the weeds — they become too focused on their models, their excel spreadsheets, or trying to predict what margins will be in 2019, etc.

I think gaining an understanding of the big picture is usually the most important objective when looking at a stock.

The big picture often means identifying the most important drivers of value in a business.

These value drivers could be things like cost advantages (Wells Fargo gathers deposits cheaper than just about every other bank), network effects (the more people that use Visa’s network, the more valuable it becomes), supply chain management (Amazon), economies of scale (Walmart’s leverage over suppliers), sometimes brands are very valuable assets (Nike, or even Apple for example), and sometimes it could be the management team that is just executing a business model well or is very adept at allocating capital (Berkshire Hathaway is an obvious example, but there are many companies that owe large portions of their success to the management team).

Many of these things can’t be measured by simply looking at the financial statements, so it helps to identify these things and keep them in mind when analyzing businesses, because often these big picture items continue to be the reasons for the company’s success going forward.


To be continued...



21 May 2016

Financial Principles by Jason Zweig. Guaranteed to Make You Smart.

Jason Zweig Investing Principles

When it comes to investing or personal finance, there’s a world of difference between a good advice and an advice that sounds good. It might not seem obvious at first, but there is.

And Jason Zweig is one of the best financial writers, who regularly doles out good advice. He prefers to say that he is not smarter than everybody else and that he only knows a lot about what he doesn’t know.

But like million others, I personally think that he is one of the best out there. In 2003, he edited Benjamin Graham’s The Intelligent Investor - a book which Warren Buffett has called ‘by far the best book about investing ever written’.

This speaks volumes about who Mr. Zweig is.

While reading through the archives of his site, I came across his set of principles (link), which I had somehow missed till now.

And this speaks volumes about my ignorance. :-)

The principles are so accurate, clear, flawless and spot-on, that I couldn’t stop myself from sharing them with you.

The principles focus on using common sense in investing and personal finance, to achieve our financial goals. And that is something, which should be everyone’s concern.

Rest of the post is about those principles. I strongly recommend you read it now, bookmark it, print it and read it again… and again in future. Atleast I will be doing it.

So here it is…

Jason Zweig’s Statement of Principles


Successful investing is about controlling the controllable. You can’t control what the market does, but you can control what you do in response. In the long run, your returns depend less on whether you pick good investments than on whether you are a good investor.

The first step to reaching your financial goals is to make sure you set goals that are reachable. Your expectations must be realistic. The stock market is not going to provide a high return just because you need it to.

The second step is to recognize what you are up against. Despite what all the daily market reports make it sound like, investing is not a game, a sport, a battle, or a war; it is not an endurance contest in a hostile wilderness. Investing is simply the struggle for self-control – the unrelenting effort to keep yourself from becoming your own worst enemy.

The market is not perfectly efficient, but it is mostly efficient most of the time. Attempting to beat the market may often be entertaining, but it is seldom rewarding.

There’s nothing wrong with gambling on poor odds, as long as you admit honestly that what you’re doing is gambling and as long as you put only a tiny proportion of your wealth at risk.

The brokers on the floor of the Exchange clap and cheer when the closing bell clangs every afternoon because they know that no matter what the market did that day, they will make money - because you tried to. Whenever you buy a stock, someone is selling it; whenever you sell a stock, someone is buying it. Most of the time, the person on the other side of the trade knows more about the stock than you do.

However, you don’t have to lose just because other people win, and you don’t have to win just because somebody else loses. You win when you stick to your own long-term plan, and you lose only when you let greed or fear goad you into changing that plan.

The right time to buy is whenever you have cash to spare. The right time to sell is when you have an urgent and legitimate need for cash. If you buy because the market has gone up, or sell because it has gone down, you are letting 90 million* strangers rule your life with their greed and fear.

* In American context

Once you lose money by taking too much risk, the only way you can earn it back is by taking still more risk.

If you lose 50%, you have to earn 100% just to get back to where you started. And if you lose 95%, you need to earn 1,900% before you break even. You may be able to do that once or twice through sheer luck alone, but the more often you have to try it, the more likely you are to end up broke.

All too many people live their investing lives like hamsters on a wheel, running faster and faster and getting absolutely nowhere.

If you want to have more money, save more money.

Investments that outperform in a bull market are certain to underperform in a bear market. There is no such thing as an investment for all seasons.

That’s what diversification is for: to protect you against the risk of putting too many eggs in the wrong basket. And buying something that has just doubled, in the belief that it will keep on doubling, is an extremely stupid idea.

Your goals are a function of all your life circumstances: your age, marital status, income, current and future career, housing situation, and how long your children (or parents) will be dependent on you. Risk is a function of probabilities and consequences – not just how likely you are to be right but how badly you will suffer if you turn out to be wrong. Investors tend to be overconfident about the accuracy of their own analysis - and to underestimate how keenly they will kick themselves if that analysis is mistaken.

Understanding your own shortcomings as an investor is far more important to your long-term success than analyzing the pros and cons of individual investments.

In the short run, hares have more fun; but in the long run, it’s always the tortoises who win the race.

Stable Investor Subscription

12 May 2016

Pay Off Loans or Start Saving & Investing?


Payoff loan or Invest Save


Should I pay off my loans or invest for future goals? Or should I simultaneously tackle both?

This and similar questions belong to a class of debate (Pay off Loans Vs. Invest), where to be honest, there is no one perfect right side to choose.

Readers of Stable Investor regularly send me questions on this topic and when I got another one yesterday, I thought maybe I should write something about this debate again. I have already written about it earlier here, but that was long time ago.

Before I share my thoughts, let me confess something upfront. I don’t like loans.

I am somehow unable to like the concept of borrowing, even though I completely understand that smart people can use leverage to make some serious money.

Generally, Indians are taught to avoid debt. That is how most of us have been brought up (exception – industrialists ;-) ).

And till few years back, many people looked down at the concept of borrowing.

But ofcourse things are changing. Slowly but steadily, we as a society are moving towards accepting the idea of preponing realization of our financial goals, with the help of loans. Very recently, a cousin of mine purchased his first real estate asset (a 3BHK flat) in a decent location in Bengaluru. Ofcourse it was with the help of a ‘big’ loan. And he is only 30 years old. Would this have been possible earlier (may be 15-20 years ago)? I don’t think so. So thing have changed a lot indeed.

Now coming back to our discussion…

The question of whether to pay off loan or invest is a very common dilemma. More so for people who have taken housing loans few years back. At that time, they took a loan, for which they could somehow manage to pay their EMIs. But with increase in income during the next few years, they now have the ability to pay back more every month, if they want to.

Example - A person had an EMI of Rs 20,000 in year 2011 when he was earning Rs 70,000 a month. Now after 5 years, his income has risen to Rs 1.2 lacs a month. So assuming (for simplicity) that his EMI is almost the same, he can comfortably choose to increase his EMIs. Isn't it?

That is true.

But housing loans are way cheaper than other forms of loans and given the additional tax-benefits, there does seem to be a mathematical case of not repaying the loan early - as effective loan rate is reduced further.

The extra money can instead, be invested in products that are historically known to give average rates of return that easily beat effective loan rates. I am referring to long-term investments in equity mutual funds.

Ofcourse there is no guarantee here. But chances are pretty high that average returns (if you stay invested for long enough) will be pretty decent.

I think the above discussion is more general and its better if I get down to the specifics…

So lets consider a scenario.

What if you have a home loan but unfortunately, almost no savings whatsoever? Whatever you have in the name of saving, is also locked up in long lock-in products like PPF.

In such a case, it’s a no brainer. Forget about paying off your loan.

Irrespective of what mathematics and online prepayment of home loan calculators tell you about interest differentials, you should carry on the loan as it is and start saving some money first. As I said, don’t worry if returns from your savings are even lesser than effective home loan rates.

Just start keeping aside some money into a sort of emergency fund. And once you are out of the situation of zero-savings-lots-of loans, only then you should think about whether to start prepaying your loan, invest for future goals or even think about getting into the home loan vs. mutual fund debate.

But wait… why are we just focusing on home loans? There are many other kinds of loans too.

So what if you don’t have a home loan, but instead have a car loan, or a personal loan or some credit card debt?

When it comes to these types of loans, its better to take help of mathematics. The reason is that these are very costly forms of loans.


Credit cardsCosts more than 40% interest
Personal loansCosts more than 15% interest
Auto loansCosts around 15% interest


Now there is no easy way to invest your money where you can be assured of getting more than 15% returns every year.

Equity MFs have given better returns in some cases, but the returns are not stable. It can be +50% in one year and -20% in another. And you don’t want to be caught on the wrong side here. Average returns are better but as I said earlier, there is more to just quoting average return that meets the eye.

So, if you have credit card debt or a personal loan, repay them first. Clear them off as soon as you can.

Note - The earlier stance on having some savings as emergency fund still stands. That’s a non-negotiable.

The need is to prioritize your loans according to interest rates and clear them off.

I have seen people paying minimum dues on Credit Card, which means they are paying 40% interest on their credit card outstandings and still investing in stock markets.

That is outright foolish, unless they can prove that they will earn better returns from markets than they are paying on credit card dues. :-)

Here, I would like to return to the emergency fund discussion again. Whether you repay your loan or you invest for future - should depend primarily on how exactly is your emergency cash situation.

Do you have stable job and have the money to take care of short-term expenses (both expected and unexpected)? Think about it.

Another point to note is that when we choose to invest instead of repaying loan, you are betting on the fact that your investments will necessarily do good. That’s easier said than done my friend. There are so many things that can go against you. Wrong choice of fund/stocks, markets going into a free fall, etc.

I am not saying its wrong to invest, when you have a home loan running. I am just saying that you need to be aware of the risks you are taking.

I am sure many of you would be thinking that I have still not said a word about the emotional and psychological aspect of clearing off loans. :-)

So here it is…

Is prepayment of home loan beneficial?

The answer depends on the chosen aspect – mathematical, emotional or psychological.

But yes, it’s a great feeling to have Zero loans - no doubt.

And it allows you to sleep well too. :-)

No amount of maths can capture this benefit in any form. So if you like me are debt-averse and prefer peace of mind to interest arbitrage, then you should payoff your loans. Don’t worry about what others are thinking about you.

You have the right to extract most units of happiness from your money. :-)

Paying off loan also makes sense when you think about the risk of job loss. So your (and your spouse’s) job stability should also be a factor when you are thinking about prepaying or not prepaying your loans…

…as defaulting is not an option – unless you are the now-supposedly in London - King of Good Times. ;-)

If you are targeting early retirement, then once again it makes sense to close out your loans quickly. But if you intend to retire at a normal pace (around 60), then investing for your retirement should also get a very high priority – somewhat similar to that given to servicing of loans.

It has already become a very long post now. My apologies.

So let me quickly list down a few points that will help you keep track of the above discussion.

Whenever you have enough surplus money to ask yourself the question - whether to payoff loan or to invest, think on these lines (in the given order):
  1. You first priority should be have a big enough emergency fund in place - which can take care of any unforeseen money requirements
  2. Identify all loans with very high interest rate (like credit cards)
  3. Get rid of them as soon as possible.
  4. Identify other high-interest loans like personal loan, car loans, etc.
  5. Also identify low cost loans (especially home loans).
  6. Under most circumstances, you can continue to invest and simultaneously payoff low cost loans.
  7. As for the high interest loans (personal and car loans), it depends on how much is the available surplus and what are the effective rates of interest. Mathematically, it might make sense to pay off these loans first, but you can take your own call.
On a personal note, if I have a personal loan that I am able service comfortably + I also have some surplus money every month + there is big market crash where there are clear indicators that investing would make sense for long term, I will go out and invest my surplus in markets instead of paying off loan. Sounds risky, but that is for me. :-)

But in case I have credit card debt (very high rates) in the above situation, I will make sure to clear it off first before investing in markets.

So as you can see, this question has no one right answer.

You can use some pay off your loan or invest calculator and come up with a mathematical (theoretical) answer. But in reality, it depends on many other factors like borrower’s exact financial situation, risk capacity, risk preference (appetite) and available alternative opportunities.

You are the best judge of whether you should pay off loans, save or invest or balance the two. Give it some serious thought if you are in that situation.



6 May 2016

Why are IPOs Overpriced & come in Rising Markets?

ipo overpricing underpricing

Another IPO got oversubscribed few days back – that too 70+ times oversubscription - I so wish that I was the seller ;-)

In recent times, the number of IPOs coming out has increased and more importantly, many of them are witnessing significant oversubscription – clear signal that appetite for IPOs is returning to the markets.

This optimism is fueled primarily by the recent upmove in secondary markets.

IPOs are known to generate a lot of emotions - both good and bad depending on how previous few IPOs have performed.

Why are IPOs Overpriced?

Now if I own a company, which is about to go public with an IPO - which means I need to sell my shares to get money - then I will make sure that me and everyone else in my team, will do everything to ensure that I get the highest possible rate for each and every share that I want to sell.

This is not greed. This is what any normal person will do.

Isn't it?

And that is exactly what a promoter (original Investor) does during an IPO.

Now lets turn around the table.

The ‘above mentioned’ promoter is selling his shares to new investors (i.e. you).

As already mentioned, his primary aim is to get the maximum amount of money for his shares.

He, with his investment banker friends sets the issue price. Remember that he still has his primary aim in mind, while setting the IPO price band.

Now as an IPO investor, you end up paying as much as the promoter wants - i.e. a lot more than what is financially necessary.

This is how IPOs work.

Few weeks ago, I read the news about how L&T had decided to withdraw the DRHP for its subsidiary L&T Infotech’s IPO. Among others, one of the reasons quoted for this withdrawal was that the valuations of company were very expensive and did not suit current market conditions.

Now just think about it.

Even the company felt that it had overpriced its share sale! :-)

Had the company decided to come out with the IPO instead of withdrawing, the investors would still have paid the expensive prices for the shares on offer.

Atleast in this case, the company withdrew its application. But in most cases, companies go ahead with their overpriced IPOs. Why say no to money coming in?

The result?

Most IPOs fail to give good returns to investors. Most promoters tend to price their public issues in a way that leaves little or almost nothing on the table for long-term investors.

I recently read in a business daily that for most IPOs, listing day gains are better than one-year returns. If that is true and my guess is that it is - then it speaks volumes about how IPOs are priced.

Talking in reference to the mistake people make in IPOs by ignoring ‘Base Rates’, noted value investor Sanjay Bakshi said:

‘Base rate’ is a technical term of describing odds in terms of prior probabilities. The base rate of having a drunken-driving accident is higher than those of having accidents in a sober state.

So, what’s the base rate of investing in IPOs? When you buy a stock in an IPO, and if you flip it, you make money if it’s a hot IPO. If it’s not a hot IPO, you lose money. But what’s the base rate – the averaged out experience – the prior probability of the activity of subscribing for IPOs – in the long run?

If you do that calculation, you’ll find that the base rate of IPO investing (in fact, it’s not even investing…it’s speculating) sucks! It’s that’s the case, not just in India, but also in every market, in different time periods.

Now I remember that in 2014, Indian Oil’s disinvestment was being deliberated by the government.

But eventually, the Petroleum Ministry rejected Department of Disinvestment’s idea of the stake sale. The publically acknowledged reason being the huge undervaluation in share prices.

But think about it.

Would it not have been a good time to buy shares of that company? I thought so it was (Read why)

The promoter’s representative (Oil Ministry) was unwilling to sell shares due to undervaluation – even when the government (actual promoter) was forcing it to (for reasons ranging from trying to reduce its fiscal deficit by selling stakes in PSUs to what not…).

The stock of the company was then trading close to Rs 190. Now the same is above Rs 400. Ofcourse low crude oil prices helped as the company belonged to the downstream sector. General rise in markets too acted as a solid tailwind.

But what I am trying to highlight here is that when promoters are not willing to sell (unless absolutely necessary), then that is a good time to think about buying. It’s a sort of corollary to the idea of stocks being undervalued (in eyes of promoters), when promoters are buying back shares.

Exactly opposite is the case during IPOs. Promoters are willing to sell their shares. So they would want to get as much money as they possibly can. This is against the interest of long term investors.

ipo overpricing jokes


Now I already said this in a post few years back and I say it again: the very purpose of a company to do an IPO is to raise as much money as possible. They are not here to do any favors to anyone. They need money and want to have as much of it as possible.

For a moment, let’s digress from IPOs and assume that you want to sell your house or real estate. You will definitely try to get the maximum price for your house, isn’t it?

You are not concerned about the buyer at all.

Don’t feel bad about it - it’s natural.

Everyone wants to get more when they are selling.

But you don’t want to be at the receiving end of such a seller’s transaction. Isn't it?

That’s common sense.


Why IPOs come in Rising Markets?

If you have been in markets for last few years, you would have observed that the number of IPOs increase, when markets are in an uptrend.

That is quite obvious as during bull markets, the perception of stock markets being a place of easy money becomes strong. This in turn helps IPO sellers to sell the IPO as dreams to potential investors. Investing in IPOs during bull markets can still be a profitable endeavour. But then again, IPOs during those time get hugely oversubscribed and allocation is pretty small. At times as low as being negligible, when considered in comparisons of overall equity portfolio.

Many people suffer from the Fear Of Missing Out (FOMO) syndrome, which pushes them towards IPOs. They put money in IPOs with the hope of making some quick gains and then boasting of high CAGRs. But for most people, hope is not a good strategy. If you are lucky, you might make money. But odds are stacked against common investors in IPO.

Older investors tell that the scene of IPOs has completely changed in India. Earlier, it was possible to make decent profits as issuers were not free to set IPO pricing – which was controlled and decided by the Controller of Capital Issues.

But now, its another ball game.

Though there is no strict IPO overpricing definition, fact is that majority of IPOs are not priced fairly – from IPO investor’s perspective. Or to put it simply, the scale of underpricing and overpricing of IPO, is skewed towards overpricing.

IPOs are built around hype and stories. And many are fairy tale stories. ;-) As the bull markets go higher, almost every story is able to excite the investors. Compelling stories allow expensive price tags to be attached to these IPOs.

But most of the (IPO) stories are not true – just like in real life. But problem is that these stories and hypes disrupt proper investing behavior.

Stories alone cannot keep the prices up. One day or the other, business does catch up with the price. Or rather, prices come down to levels of the real story behind the business. :-)

And this is not something new.

Hype was that caused Tulip Mania in the 1600s. Remember Reliance Power’s IPO? The company was selling the hope that it will construct power plants and change the power sector forever. It was a one of the biggest IPO overpricing example in Indian history. Very few even bothered to have a look at NTPC, which was available way more cheaply and had actually set up large power plants!

It is amazing how people will not do simple things to make money!

Start early, invest regularly, do not interrupt the compounding process... but will continue to do stupid things.

In general, IPOs are only launched keeping in mind the interest of existing promoters and investment bankers. There is a reason why they tell you to read the offer document carefully before investing. ;-)

If you are a long-term investor, you are better off looking for good stocks in already-listed stock space.

In fact, one of the big incentives for an IPO is so that previous investors – founders, venture capital firms, and large individual investors – can “cash out” at least a portion of what they’ve invested. That is why most IPOs are often expensively priced.

Now Warren Buffett has been quite vocal about his distaste for IPOs. This is what he had to say in a letter published in 1993:

…intelligent investor in common stocks will do better in the secondary market than he will do buying new issues… market is ruled by controlling stockholders and corporations, who can usually select the timing of offerings or, if the market looks unfavorable, can avoid an offering altogether. Understandably, these sellers are not going to offer any bargains, either by way of public…

11 years later (in 2004), he had some more wisdom to share about the IPOs:

“An IPO is like a negotiated transaction – the seller chooses when to come public – and it’s unlikely to be a time that’s favorable to you. So, by scanning 100 IPOs, you’re way less likely to find anything interesting than scanning an average group of 100 stocks.

The seller of a $100,000 house in Omaha will never sell for $50,000. But if 100 entities each owned 1% of a basket of homes in Omaha, the price could be anywhere.”

At the end of the day, it comes down to the need for investors to understand - that IPOs are designed to benefit promoters more than investors. If they don’t understand this, they will eventually end up loosing money.

And as Late Parag Parikh said: If consumers are irrational it makes sense for companies to cater to that belief rather than eradicate it.

Sounds logical to me. :-)

Now its possible that going forward, markets might show signs of further revival. This in turn, would mean that companies would become ready to come out with their IPOs and FPOs.

The IPO sellers will start projecting these new companies as investments that can take you portfolio to the sky.

But remember, that the IPO sellers have the luxury of deciding the timing of the sale, i.e. they can choose to sell only when they get high prices for the shares. And that is what they will do.

Now for a moment, give it a thought. Why don’t IPOs come in Bear Markets? Or why does the number of IPOs hitting the market fall down when markets are not rising?

Mr. Parikh once said: “Companies don’t want to sell their shares in a bear market because they won’t be able to get a good price. But then where is the logic for investors to buy these shares in a bull market, when valuation is high?”

I am sure that many people will still be interested in investing some money (say sin money) in IPO.

I am not stopping you.

Please go ahead and do it.

But just remember that you are buying shares from someone, who knows much more than you about what he is selling, has done everything (right and wrong) in last 1-2 years to make the financial statements look good, paid good money to merchant bankers to spread good words and stories about the company.

As IPOs in initial phase come out and start trading at significant premiums to their offer price, this gives a confidence boost to the next line of not-so-good companies, waiting to tap the market.

So the momentum continues to build up unless it stops. And as noted professor Aswath Damodaran says, the IPO game is a subset of the momentum game. It is a game that produces big winners but momentum always turns, and when it does, it creates big losers.

So keep you eyes, ears and place where common-sense resides, open. :-)

To be fair, there have been some good issues in the past and its possible that good companies might come up with an IPO that is worth investing. But identifying the ‘goodness’ of the company in itself is a very big task.

Most IPOs are not good for most investors – and hence, there is no reason for common investors to try and portray that they know the value of company better than the person who is selling his stake in the IPO.


Suggested Reading:

The Economics of IPO (and other) Markets (by Sanjay Bakshi)

You can read the full article here. Or can go through some IPO relevant extracts below:

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Any kind of rational comparison of long-term returns in the IPO market and the secondary market would show that investors do far better in the latter than in the former. Indeed many such comparisons have been done which cover data taken from several countries spanning over decades. The conclusions are always the same: that IPOs are one of the surest ways of losing money in the long run.

There are certain characteristics of the IPO market, which makes it unattractive for long-term investors.

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The IPO Market It is only to be expected that in a bull phase of the stock market, there will always be a sector, or a group of sectors, which are viewed extremely favourably by the investment community. These favourable views of the investment community are expressed by it in the form of high price/earnings, price/book value, price/sales and price/cash flow ratios commanded by the stocks of publicly owned and quoted companies.

At this time, privately-held companies in such sectors find that they possess an unlimited supply of extremely desirable "merchandise" i.e. their own shares.

Naturally, merchant bankers scramble to advice these companies on how to raise a large sum of money from the equity markets at inflated prices. (The recent development of book building for IPOs is nothing but an artful form of pitting one bidder against another in an attempt to create a high clearing price for the shares being offered).

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Four characteristics of the IPO market make it a market where it is far more profitable to be a seller than to be a buyer.
  • First, in the IPO market, there are many buyers and only a handful of sellers.
  • Second, the sellers, being insiders, always know more about the company whose shares are to be sold, than the buyers.
  • Third, the sellers hold an extremely valuable option of deciding the timing of the sale. Naturally, they would choose to sell only when they get high prices for the shares.
  • Finally, the quantity of shares being offered is flexible and can be "managed" by the merchant bankers to attain the optimum price from the sellers' viewpoint. But, what is "optimum" from the sellers' viewpoint is not the "optimum" from the buyers' viewpoint.

This is an important point to note: Companies want to raise capital at the lowest possible cost, which from their viewpoint means issuance of shares at high prices.

That is why bull markets are always accompanied by a surge in the issuance of shares. It is true that often hot IPOs list at incredible premiums. The reason is simple: the demand for the shares being there, the merchant bankers ensure that only a limited supply is released to ensure a high price on listing.

Super profits are made by those who get shares allotted to them in the IPO, so long as they sell them at, or soon after, the initial listing.

This is where the trouble begins. Everyone wants a piece of the hot IPO cakes. Everyone thinks that he will get out at the top. Mathematically speaking, obviously this cannot be true. Moreover as time goes by, the investment quality of the issues tends to deteriorate.

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