Remember the days when we wrote exams on paper sheets, there was a generally accepted norm to score well. Write more pages, take extra sheets. Regardless of the content, the first impression on the examiner would be — this student has put in the effort and knows quite a bit. If you can't answer the specifics, more words and pages could help. In a cumbersome process of examining papers and teacher fatigue, somehow it worked.
The DRHPs for IPOs are no different. Although the information needed to value a company can be summarised in 10 pages, what we get is 600 pages of the dump. You are the examiner here. Good luck!
If you've found yourself in this situation after downloading the recent DRHPs, let's examine some critical pointers to look for before you decide to buy that
IPO. This is in no way a comprehensive list but gives you broad pointers to explore. The first pages to search are the balance sheet, income statement and cash flow statement. These are mostly one after the other.
Sales growth-consistency and quality: Most IPOs of new-age companies love to quote rising sales. In absence of profits, this is the only metric they want to be valued for. The story however is far from simple. Many recent companies have tried various diversifications and folded many failed initiatives. In many cases, they have acquired companies just to buy topline. One should explore the products and subsidiaries that contribute to sales growth and has that been consistent? In many cases, we see that while the overall number is growing, there is no specific product line that is gaining leadership on the ground. In many cases, there is other income that inflates the sales. Not the growth you’re looking for.
Market Leadership/dominance and market potential: The second area to explore is overall market potential and the company’s share of that market. Don’t get carried away by the future market size projections. Most of the reports quoted there are created just for IPO purposes. Try searching for the growth and market size for the last decade vs the future. India wasn’t that bad in the past 10 years too and it is unlikely to change drastically in the next decade. The truth will be somewhere in-between. If the market grows by 10 percent, a company can’t grow at 25 percent plus unless it is grabbing share from existing players. Sounds easier than it is.
Gross margin and Unit economics: This question touches the heart of valuation i.e. earnings. Ultimately you buy a stock for its profits or potential to earn profits. Examine gross margins and promotional spends. Notice the co-relation between promotional spends and sales. Do the gross margins justify that the company has a strong moat in the market of is it just selling because of heavy promotions. Remember, the Indian consumer is very sensitive to price. If a company is paying its way to market share, there will always be some new player who will take that market away. Recall what happened in telecom when Jio arrived. Apply basic financial sense: Look at comparable companies in the market. Every company claims there is no competition for them, but there always is. Regardless of online or brick-and-mortar debates, look at the core product the company sells. Amazon is basically delivering the same products that you used to buy in the market, only cheaper. Most of the new-age companies are selling the same products cheaper and in a convenient way, nothing more. But the incumbents will not sit and twiddle their thumbs. In most cases, the competition bounces back and fast. In many cases like banking, it is very difficult to sell products online especially on large amounts and that’s where the profits are. Each industry is different and the growth trajectory for any company can’t be a straight line. If a company claims to grow at 30 percent each YoY for the next decade, it can’t be true for most. Things will change. The competition will emerge. Don’t price abnormal growth numbers in your models.
Finally, look at the current investors and sellers: They say, before you buy anything, look at the seller. It is hard to get a good bargain if people who’re selling are bigger and smarter players than you. Even on a used car, you always ask who owned it earlier and why are they selling. IPOs are no different. IPOs sold by private equity players haven’t done good for retail investors in most cases internationally. Remember — Everything is good at a price. Not beyond!While it may be hard for retail investors to explore fine print and accounting changes in annexures, I’m sure the above pointers will address broad valuations parameters for most IPOs. And if the answers to the above are not very clear in the DRHP, think for a moment — Why has the company filled so many pages? Don’t reward a thick answer sheet.
If you don’t understand what you buy, you’re just buying another Tulip flower hoping that someone else will pay even more for that. It works for a while until it doesn’t.
The author is Managing Partner Ansid Capital, a limited partnership hedge fund. He tweets at @anuragsingh_as and is an ardent follower of the value investing school. Views expressed are personal
(Edited by : Ajay Vaishnav)
First Published: Dec 7, 2021 10:46 AM IST
