Investing in IPOs in India is a FREE LUNCH....

Economics textbooks have for long taught us "There Ain't No Such Thing As A Free Lunch".However, the Indian primary market seems to be an exception to this rule. A study of over 100 IPOs in the past three years reflects the same. A spreadsheet of the study can be downloaded from here.

Some brief numbers:

No. of IPOs: 100
Coverage period: late 2005 - 2007 till date.
Returns computation: Avg Price on the listing day over Issue price.
Avg. Price defined as Average (Open + High + Low + Close).

Result:

IPOs with +ve first listing day (i.e. avg. price > issue price) - 73
IPOs with +ve opening (i.e.open price > issue price) - 78
Average Gain to an investor who sells on the Ist of listing : 24.3%

I think it is this free lunch that has caused so much trouble in the IPO market. The IPO scam that was unearthed by the SEBI last year. The scam in brief was this:

"It involved manipulation of the primary market—read initial public offers (IPOs)—by financiers and market players by using fictitious or benaami demat accounts. While investigating the Yes Bank scam, Sebi found that certain entities had illegally obtained IPO shares reserved for retail applicants through thousands of benaami demat accounts. They then transferred the shares to financiers, who sold on the first day of listing, making windfall gains from the price difference between the IPO price and the listing price."

Any investment that earns returns (above the risk-free rate) without any risk will attract infinite investors. However, since the supply of IPO stock is limited, and there are limitations to how much one can apply, there is a mad rush to invest in IPOs.