There are volumes of information in a public issue prospectus. But retail investors do not have access to one crucial number, that is, expected profits, that determines the most crucial aspect of a public issue—valuation

The Indian public issue market has evolved significantly over the years. Gone are the days when a small fly-by-night operator could easily raise a few crores with the help of a skimpy prospectus, a shady investment banker and some persuasive articles in the media. That was in the '90s. The mis-selling and mis-pricing was so severe (in one week of February 1995, as many as 74 issues, mostly shady companies, opened for subscription), that we suffered a phenomenon of 'vanishing' companies. The new issues market went into a coma for the next 10 years. Things have changed. We now have a market for Initial Public Offerings (IPOs) that is more sophisticated. Smaller companies cannot make an issue easily.

But can a thoughtful retail investor know enough about an IPO? Well, despite the vast improvement in IPO rules and disclosure, retail investors have to decide whether an IPO is good or bad based on two things: the past data and the IPO ratings. Past data is not that relevant—except for very large companies—and IPO grading does not give any indication of the valuation based on future earnings.
To judge an IPO, one has to know about the fundamentals of the business and promoters. This is now available thanks to IPO ratings put out by rating companies. But the single biggest decision about an IPO is the price—and for that, one needs to know the future profits to check whether the IPO is overpriced or not.

What investors need is opinion from multiple sources as to what the company's earnings would be a year forward - which alone influences whether the current valuation is attractive. This valuation becomes the basis for investment for retail investors. The only source of information that is available to the retail investors is the company prospectus. The prospectus will have a long list of the company's past data. The current regulations bar a company from discussing future expected earnings. This rule was made to prevent too rosy a picture being presented as was happening in the '90s. But does it really help the retail investors?

Remember that nothing is really known about a company making an IPO. There is no trading history of the company. No reports, no filings with the exchanges. The financial past, which is available in a thick prospectus full of legalese, may not be very useful. After all, as long as a company is unlisted, the promoters are free to do what they feel is right. The promoters of unlisted companies do not have to disclose anything about operations to the public, nor are they answerable to anyone as long as they are within the law. Indeed, given how easy it is to get around Indian laws, there is a temptation to depress profits by paying low taxes when the firm is unlisted and to boost profits in a year before the IPO to show how well they are doing to the investors. In such a scenario, when a company plans to go for an IPO, the most important factor is the future prospects of the company. The past earnings mentioned in the prospectus have no relevance, as the governance levels before and after the issues would be very different.

All this makes it really difficult for the retail investor to take an investment decision. For institutional investors, it's not that difficult because the lead managers and their analysts are desperate for their subscription. They would bend backwards to supply institutional investors with all the information and research they want about future earnings. Unable to decide what the real valuation of the company is, nobody thinks he is buying a decent bargain when he subscribes to an IPO. He thinks of flipping it to the greater fool on the listing day. In the next part we will look at some examples of how expensively companies have been priced, their earnings and pathetic post-issue price crash—all because so little is available in the public domain about future earnings.