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Beware! Valuations being engineered in low-float IPOs & stocks, warns Shyam Sekhar

Dalal Street veteran Shyam Sekhar has warned investors to not fall for debutant stocks or old companies with low free-float, even if their business fundamentals look attractive. “They may or may not prove a good investment,” says he.

Even if they have delivered strong growth, say in FY20 — a year of scarce earnings — and may have reasonably predictable margins and return metrics, they are risky and their public float may have been designed in a way to command higher valuation.

Sekhar – a value investor and Founder and Chief Ideator of the Chennai-based iThought Advisory – said while there is nothing objectionable about these companies, the valuations that Dalal Street is assigning to some of them may not be reasonable enough to reward investors in the future.

“Many companies are brought to the capital market in this way to engineer higher valuations. From the investment banking stage, there is a design of not creating high floats. The instrument preferred is a 10 per cent stake sale in IPO. So, when you sell 10 per cent in an IPO, the rest 90 per cent is held by the promoters, who get time to dilute the stake further. In this period itself, the company performs well, people become more cognizant and the story is built to create an aura around the company,” he said in a video which he shared on YouTube on Tuesday.

“Then a few big investors chase the float. It’s very easy to corner a good part of a 10 per cent share which is in public ownership. And the valuation goes up. This sets it up very nicely for the promoter to sell the next tranche at a higher valuation. Since a lot of institutional investors wait to get in, they buy those shares at a higher valuation. They corner whatever is offered to the public. This pattern has been repeated in a number of IPOs of late,” Sekhar claimed.

He said there is no denying that many of these companies could be fundamentally good, but the way in which their valuations are engineered is certainly not the right thing to do.

“The engineered approach to valuations is what institutions have preferred, as it is very convenient for them as they don’t see volatility in their NAVs and they’re able to buy large parcels and just sit tight on them. There’s not much maintenance effort after they made the investments. And this is sustainable for them, because further supply on the counter is not going to come very soon,” he said.

Such a trend is not specific to the IPOs alone, it is also being seen in companies, where there is 75 per cent promoter ownership.

“Suppose a company has a 26 per cent free-float share and somebody goes to corner a very high percentage: in some extreme cases, it could be as high as 10 per cent. Typically mutual funds are guilty of this, but PMSes are also no less guilty. Here people are not acting in concert, but they are investing in concert,” he said.

“Because one big guys get in, others get it at a much higher price. In these kind of stories, there is no float after a while. Imagine those investors who got in early, coming out extolling the virtues of these companies every day on television or periodically maybe in their newsletters or even the TV picking up the news because the price starts moving. Only after this, would retail investors rush in and inflate the price to absurd levels,” he said.

Shekar said informed guys buy first, then come the second layer of informed guys. It is followed by periphery and lastly retail, he said. “This whole thing may eventually not pay well, or in the best case scenario, may lead to long-term correction in the hands of retail investors,” he said.

“When we say something is happening in the market and the ecosystem is not in the favour of the investor, most investors tend to associate that opinion with the company for which it is being spoken about. But this is not a company-specific problem, this is a serious ecosystem problem. Unless as a retail investor, you understand the darker corners of the ecosystem, you’ll become the final product,” he said.

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Sekhar seems to be raising a serious issue. We would like to hear your views on this. Write to us at [email protected]

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