Many equity investors often wonder about the raison d’etre of the stock market – does it add value to society or is it just a place where scraps of paper trade at some price. One of the main objectives of the secondary market, where stocks get traded among different investors, is the primary market, through which companies raise money from investors.
There are several reasons why a company may decide to get listed. A large number of companies have been funded by venture capitalists or private equity investors. These investors typically invest at an early stage and can get potential liquidity for their investments through a listing of the stock in the public market. Another possible reason could be that the promoters may want to create liquidity for themselves and other shareholders. Sometimes companies go public because they want to grant ESOPs to their employees and the listing provides a way for employees to exit at a time of their choice. The most common reason though, is to raise equity funds, the size of which it is no longer possible for the promoters, or other private means, to contribute on their own. The existence of a healthy primary market (where companies raise money through a public issue for instance) is vital for the growth of the corporate sector and is a sign of the health of the capital market.
After being moribund for a few years, we have, over the last 18 months seen some pick up in the primary markets, though the numbers still remain way below the figures observed in prior years such as FY2008 and FY2010-11. It has been observed that primary market activity picks up during bullish phases of the market. This happens because the secondary market is placing a high price on existing listed stocks and this prompts companies to choose such times to approach the primary market. What is to be remembered here is that the timing of a primary market issue is dependent on the seller of the stock, and not on the buyer, and therefore sellers are likely to choose a time that is favourable to them. However as time passes, either because of price correction, or growth in earnings, these issues can become attractive for a patient investor.
We have seen activity pick up in the primary market and have recently seen issues from a wide variety of issuers such as insurance companies, stock exchanges, HR services, pathology labs and retailers, to name a few. This lends greater depth to the stock market as a greater variety of businesses get traded on the exchanges offering more choice to investors, including ourselves.
Most of the companies in which we invest, generate free cash flows on a regular basis – hence their requirement for money from outside sources is small – they are usually able to manage their capital requirements either from internal sources or through a small quantum of debt, if the need arises. We are fortunate that some of these companies did approach equity investors at some point of time, either for regulatory reasons or to create liquidity for some shareholders and thereby, provided us and other investors with an opportunity to buy into these businesses. We continue to hope that more good companies in varied businesses will find their way to the primary market and thus allow investors to participate in their growth.