Stock market. Why IPOs don’t make you rich

With recent Initial Public Offers (IPOs) delivering blockbuster returns, are you beating yourself up for not applying? On the face of it, the absolute return of 80 per cent on the Zomato stock or 109 per cent on the Tatva Chintan Pharma stock within a few days of the IPO may appear a huge missed opportunity.

But if you’ve been regretting this, you can rest easy. Retail investors in India have a rather low probability of bagging allotments in fancied IPOs. The more heavily subscribed an IPO, the less your chances of winning the allotment lottery. More important, winning the allotment lottery doesn’t mean much. Retail investors who do get IPO allotments usually get such low quantities of shares that it hardly makes a difference to their wealth - even if prices were to double on listing.

Allotment lottery

To know why, you need to know SEBI’s rules on the allotment process for retail investors in IPOs. Book-built IPOs in India are required by regulations to reserve quotas for QIBs (qualified institutional buyers), Non-Institutional Investors (NIIs) and retail investors. Individual investors placing bids of upto ₹2 lakh are treated as retail and those with bids above ₹2 lakh are classified as NIIs.

Investors who bid in IPOs are required to put in applications for at least one lot of shares. Allotments too are made based on the minimum lot size, which varies across issuers. In the Zomato IPO, one lot was 195 shares, in Tatva Chintan Pharma it was 13 shares and in GR Infraprojects it was 17 shares.

Until 2012, the rules required companies to allot shares to all bidders in a book-built IPO on a proportionate basis. But in 2012, to democratise allotment for retail investors, SEBI decreed that all retail bidders should be allotted at least one lot, irrespective of their application size.

When IPOs are under-subscribed or feature a small retail over-subscription, issuers are able to allot one lot to all retail bidders. But in heavily over-subscribed IPOs, issuers find that there are not enough shares to allot even one lot to all retail applicants. In such cases, they choose retail investors who will get one lot through a lottery system. When an IPO is highly fancied, retail investors need to win this draw of lots to bag any allotment. Even if they get chosen, they can hope to receive only one lot of shares, irrespective of their application size.

Modest gains

How this works is better understood by taking live examples of the recent IPOs. The Zomato IPO for instance, had reserved 12.27 crore shares for retail investors but received 27 lakh valid retail applications for 83.04 crore shares. This made it impossible for it to allot one lot to all retail investors and allotments were decided based on a lottery.

The basis of allotment document shows that retail bidders were allotted shares in the ratio of 116:469 for smaller application sizes and 23:93 for larger ones. That is, in the lottery only one in every four retail bidders got allotment. In line with the rule, all these winning bidders, whether they bid for just one lot (195 shares) or the maximum of 13 lots (2535 shares) received identical allotments of 195 shares.

In effect, whether you put in an application for ₹14,820 (195*₹76) or ₹1.92 lakh (2535*₹76), you received Zomato shares worth just ₹14,820 (if you were lucky). Therefore, the maximum gain that any retail investor could have pocketed on the Zomato IPO till date is ₹11,310. While this may seem like a nice round sum to make in a weeks’ time, it will not make a significant difference to one’s net worth.

The retail allotment pattern in Tatva Chintan Pharma, an even more heavily over-subscribed IPO (retail bids for 35 times) drives home the point more forcefully. Given that the retail quota here saw a mad scramble, only 4 in every 100 retail bidders were allotted shares (allotment ratios were at 16:365 and 5:114). Irrespective of whether a retail investor put in an application for ₹14,079 (one lot) or ₹1.97 lakh (14 lots), he bagged just 13 shares. Despite the stock more than doubling post listing, at the current price of ₹2270, the maximum gain that any retail investor could have made is ₹15,431.

The NII gambit

If ‘democratic’ allotments in the retail quotas of IPOs prevents you from making big gains, can you beat the system by bidding more than ₹2 lakh in the NII category? This does improve your chances of allotment, but does not guarantee a meaningful number of shares.

Given that NII portions of fancied IPOs also get heavily over-subscribed, investors who put in lower application sizes within NIIs again have to rely on a draw of lots. To bag assured NII allotment, your application size has to be really large.

For instance, to bag assured allotment in the Zomato IPO, the minimum NII bid you had to place was for 7990 shares or ₹6.07 lakh. But even these NIIs received allotment of just 233 shares. To get a meaningful allotment of Zomato shares worth ₹1 lakh, you needed to put in an application of over ₹40 lakh!

This IPO math in fact drives home an important lesson on wealth creation from equities. To make meaningful money, you don’t just need your stock to deliver blockbuster returns, you also need to own a meaningful position in it, in your portfolio. This is indeed why many seasoned investors prefer to skip the IPO allotment scramble and accumulate IPO companies, if they prove good businesses, well after listing.