Valuation 101, Are IPOs valuable?

[richa94]

Let’s say you want to buy a DSLR to make YouTube videos. The MSRP is 50k.

The seller asks you for a 10% premium because you will make money from videos shot on that DSLR. You agree.

But then he demands a 20% premium, claiming that not only will you make money, but you'll also make more videos, and he wants a cut of the potential earnings. You agree.

Then he demands for a 30% premium, claiming that as you make more videos, your engagement rate will increase, and you'll start making more money per video, so he wants a piece of that as well. You agree.

Then he asks for a 40% premium, saying with such a level of engagement, not only will YouTube pay you but brand deals will happen, so he wants a share in that as well. Do you agree?

Something similar happens in IPOs and market in general. Once you pay such premium, you have indirectly made a lot of promises, have not left any room for growth, and have cashed in on future growth.


Let’s consider Ethos IPO.

Pre IPO Ethos’s equity was about 157cr.

Post IPO equity would be about 532cr.

Ethos asked for market capitalisation of 2315.72cr at IPO. 4.3x their book value

The company made net 5cr on average in the last 4 years.

The question is how many years Ethos will need to justify a market cap of 2315cr with their fundamentals, assuming a 5% YoY increase in net profit and ignoring the effects of interest and inflation?
About 64 years.

There are quite a few things to consider here. One, if Ethos shares remain in demand, their share price would factor in their profit growth, and shareholders might be able to sell Ethos shares at an even higher price.

Two, earnings potential. Ethos will most likely use the money from the IPO to expand its ventures and create more wealth. Exponential earnings, reducing the time required for IPO candidates to break even.

But, think about it. Aren’t they cashing in on very long-term growth or are they promising exponential earnings in a decade or both?

To me, it sounds kind of similar to our DSLR example. The point is, you are an investor. You too want profit. If Ethos is going to ask for all those years of earnings right now, how do you make a profit?

 

[nol]

@richa94 It is generally accepted that IPOs are the worst time to buy due to knowledge asymmetry. You can wait till the lock-in for the key investors etc is over (3m? or 1 year? I forget) and buy at a massive discount then since all many insiders are busy unloading.

 

[gabby_123]

@nol Is it always true though? I legitimately don't think so, as nothing is always true. I bought a company I've been holding on to for the last two years, tracked its price graph from the very beginning and bought as early as I could. It didn't go down, and is now 4-5x return for me.

I've also tracked prices for certain other companies, and they weren't losing propositions either over 2-3 years. In fact, some multiplied to 10x. Bought another one when funds were available (3-4 months after opening), it is currently at 2.5x the price.

Obviously this doesn't apply to all IPOs (may even apply only to a select few), I'm making a specific observation.

 

[brettb]

@richa94 Nowadays many IPOs are coming which are commanding sky high valuation. In my view, this can be dangerous as company would need double digit growth for years on end or the valuation will crash. Thus, such investment option needs to be avoided.

Disclaimer: Securities Market is subject to Market Risks, please consult your Certified Financial

Advisor before investing.

 

[thriftfabulous]

@richa94 > Ethos will most likely use the money from the IPO to expand its ventures and create more wealth

The question remains - how large is their target market? How fast is it growing?

Most Indian startups and recent IPOs have raised money at valuations that grossly overestimate the size of the Indian market

 

[tonedr]

@richa94 Nice analogy!