In my search for high returns in the equity market, one recent strategy I came across was rights issue. It is the practice of raising funds from existing shareholders by creating new equity shares. The company allows existing shareholders to bid for the new shares at a discount to the CMP before releasing them to the general public. The maximum amount of shares existing shareholders can bid for is proportional to their existing holdings.
In addition to rights issues, another method utilized by companies to raise capital is through Qualified Institutional Placements (QIPs). While rights issues involve offering shares to existing shareholders, QIPs involve the issuance of shares to qualified institutional investors, such as mutual funds, insurance companies, and banks. Unlike rights issues, in QIPs companies directly approach institutional investors to subscribe to the new shares.
Do QIP and Rights Issue provide good returns? The broader public opinion might be "depends" but my personal opinion is skewed towards "yes". So does this mean subscribing to such issues surely leads to high returns? No. But looking at the data of the past few such issues, I figured out a trend and a little research behind it brought out consistent results. So here it goes.
Understanding the price movement - The winter is coming
Let's look closely at the price movements of equities leading to the last day of the issue. The structure behind the issue is that the company has some amount of outstanding shares in the market, based on which the market cap is derived. When you suddenly add a huge number of shares, the individual share value dilutes. This is because if the price per share remains the same, the total market cap of the company would increase and the instantaneous increase of the market share out of thin air cannot be accounted for. The company takes into account the dilution in shares and provides the new shares at a lower price than CMP. In addition, some companies may provide additional discounts to the subscribers of these issues as an added incentive. This means that attributing to the correction, market prices fall to meet the price at which the rights were issued. So we come to our first conclusion
CMP comes down around the last day of the issue.
What comes next is interesting
The capital that the companies have raised is used for clearing off debt or funding growth for future expansions. When a major chunk of debt is cleared of the company books, a lot of capital expenditure is saved in terms of interest payment leading to higher net income. In the other case when it is used for expansions, it itself can lead to higher net income. This means companies with strong financials perform really well in the long term. But this is a completely fundamental viewpoint for investment. Here, we are looking for explosive short-term growth, not long-term investments.
Things change when we look from a short-term technical standpoint. We will focus on companies that have a decent market cap - more than Rs. 1000cr to be precise and decent financials(doesn't need to be too outstanding). After the correction, when the prices reach the issue price, they gain a lot of demand. Past trends show an upward movement of around 15% minimum for most issues.
In stocks having decent market cap and financials short term bullish bursts can be seen.
How to trade around such issues?
The most obvious strategy is subscribing to the rights issue and holding it for some time. However, in this case, the pre-requisite is holding shares of the company beforehand on a set record date. This translates to blocking up capital, even if for a short duration. Even so, the market tends to correct itself to the issue price, even if momentarily. This means you could also have bought the shares via open market around the issue price. Additionally, prices may also fall after the rights issue. This would lead to an unexpected loss. Buying into a rights issue is only beneficial if the issue price is hugely discounted against the CMP. For eg, PNBHOUSING issues rights @275 and the CMP was still increasing from ~410 to ~440. This heavy discount of 50% means it is highly unlikely for prices to correct 50%. Instead, it was seen that prices kept rising.
PNBHOUSING (15% short term uptrend and prices kept rising even after that)
The second strategy, and the one that I prefer, is a trend-based one. Due to an increase in demand because of new shareholders and other factors, the prices shoot up, even if for a short term. The uptrend, although cannot be accurately predicted can range anywhere starting from a modest 15% within a month. Personally, I have bought symbol(s) on the open market after the rights issue or the QIP on a couple of conditions.
The first is that there should not be a severe drop in the CMP. A high fall in the issue price suggests that the market does not find the issue attractive and is sceptical. Though there is a possibility of an uptrend in the near future for such stocks, it should be avoided in the meantime till selling is over. One can enter the stock after selling is over and signs of uptrend can be seen. Personally, I still avoid such cases as much as I can. For eg., in MAHABANK, there was a sharp fall in CMP below the issue price. Even still, owing to the strong financials of the company, the prices bounced back and showed a strong uptrend. The selling could have been intentionally done to weed out retail investors and hit stop losses.
MAHABANK (13% short term uptrend after which an consolidation is seen)
Alternatively, if the price action seems strong and the symbol shows signs of consolidation or uptrend after the issue date has crossed and the CMP has almost reached the issue price, I find it a good time to enter the stock. After a rights issue or QIP, I have always seen strong price movements on either side so I hold the stock for a high Risk-Reward ratio, which I set dynamically based on the company and market sentiment.
Allow me to share a few more examples to prove my point.
- SOM DISTILLERIES & BREWERIES LTD. (Rights Issue)
SDBL (51% short term gains followed by further uptrend)
- PATEL ENGINEERING (Rights Issue)
PATELENG (44% short term gains followed by further uptrend leading to 200%!!)
- DATA PATTERNS (QIP)
DATAPATTNS (29% short term gains followed by further uptrend)
Conclusion
Rights Issues and QIPs are really great opportunities for high short-term returns. Buying after the issue date around the issue prices ideally is the best way to earn the aforementioned short-term returns. However, it is best not to participate if the prices fall too much after the rights issue as this shows that the market might not favour the capital utilization of the given stock. It is also best to go for companies having a decent market cap.
DISCLAIMER: I am not a SEBI-regulated or authorised person and none of the above is any recommendation of any kind.