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How to know if the latest IPO is right for you? Nithin Kamath explains

One of the reasons why start-ups do well is also because they are quite nimble in the way they operate and raising public money actually reduces the nimbleness, says Nithin Kamath, Founder & CEO, Zerodha.

Sebi on Tuesday proposed putting a cap on IPO proceeds earmarked for making future acquisitions without identifying specific targets and monitoring funds reserved for general corporate purposes. People are allowed to use 25% of the proceeds for general corporate purposes; if that is raised to 35%, is that going to stop a Zomato, Nykaa or a Paytm from going ahead with acquisitions from IPO proceeds while still awaiting to deliver a profit?
I think the intent here is to disclose more and just to set a precedent that these companies will have to come out and disclose if they plan to acquire a business with IPO proceeds. I think that should be made and the intent should be put out upfront. This is one of the concerns I had about some of the start-up listings. One of the reasons why start-ups do well is also because they are quite nimble in the way they operate and raising public money actually reduces the nimbleness. We need to see how all of these companies manoeuvre around all of this but yes, it is a tricky place to be in.

One must talk about the agility of the start-ups. Zomato went into IPO talking about how it wants to be in grocery, how it is going to bet big on wellness and nutrition and supplements. But within 11 months of acquiring that business, it has sold it and now made three new investments in either adjacent or non-adjacent spaces. Isn’t that the nimbleness of a start-up that the public market needs to start recognising?
No, it will take some time. Zomato is really the first large start-up listing but like I said earlier, the start-ups have to adapt because if they lose the nimbleness, they potentially can lose an edge they have and there is so much competition today. That really has to be a concern for all listed companies I guess.

The Paytm IPO is listing today. I was going through one of the Zerodha blogs and you had tweeted it out as well — a check list of sorts for the new age companies. Do you want to take us very quickly through that?
Yes, sure. There is a lot of interest in all of the new companies that are listing. You cannot really evaluate these companies based on your traditional benchmarks of price to earning profits and profit growth etc. So we put out a post to help our users figure out some of these things. Broadly, the world has moved away from valuing companies based on past financial records to like future growth. So the biggest point in the check list is whether the company is growing and if the user growth narrative is going to stick around and if that user growth narrative is even real.

In today’s world, in India showing user growth is not really very hard. You can spend a few hundred rupees and kind of apply the customer. But does the customer eventually yield something as a business and is your long term value from the customer kind is more than the cost of acquiring that customers?

So the checklist is mainly to see if the company is in a space that is expanding very fast and the target market is expanding very fast and two is if that the growth is real. If you tick the box against these two questions, you could consider investing in these companies because some of these companies may not survive because they do not really have the profits and revenues. If there was a long winter, I do not think many of them will survive because they are not generating any money as business; but I also think that a lot of these companies will end up making a lot of wealth for investors.

So the most important aspect of investing in these high growth high risk stocks is just to allocate a small portion of your portfolio to it and think of this as extremely risky stocks and even within that allocation, diversify between two, three, four, five such stocks and not be concentrated in one. That is really what we wanted to hint in the post saying that you cannot really pick one Amazon, you cannot really pick one Tesla, you probably pick 10 companies and may be one turns out to be Amazon. That is a more reasonable expectation than hoping that the company that you pick will turn into a multibagger.

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