What You Need to Know Before Buying IPOs, when considering buying initial public offerings (IPOs), it is essential to understand what we are getting ourselves into. There are many lead managers and lawyers making money on IPOs, but for the rest of us, the investors, it isn’t always the case. It’s easy to wind up buying over-priced companies tied to less than inspiring sectors. There are endless numbers of IPOs on the ASX that seemed promising, but wound either sputtering along above the issue price for a short time and then crashed or it simply took a nose dive out of the gate.
So, what do we need to know about future IPOs comprised of tech-stocks, LICs, telcos, agri-stocks and resource stocks? Let’s explore some guidelines.
- Do the research- We should never jump into buying anything before doing our homework. Always look into prior financial statements of companies. Also, make sure to investigate what the money being raised is going to fund. Is it to pay for expansion? For repaying debt? We should also determine how much is to be paid to existing owners. My best advise is to consult with trusted investing professionals before spending any money.
- Time it right- Especially when a stock looks over-priced, if an IPO that is otherwise good seems like it is going to wind up riding the waves in a negative market, then we may want to buy the stock on-market after it is listed. We should also do a comparison between its likely issue price and the issue prices of similar stocks on the market. If we find that there’s a clear premium, we should do our best to determine whether it’s warranted in relation to its current and future potential earnings.
- Think twice about stagging- Purchasing IPO’s for ‘stag’ profits in light of how many stocks trade lower than their float price is not a good strategy. We can hurt our chances to make future trades because there are financial institutions that do not like staggers.
- Balance sheet basics- We should be looking for the floats of companies that have little debt, not a lot of goodwill and a consistent, better than average return on equity (ROE) on their balance sheet. Also, it is important to stay away from floats that have negative net tangible assets (NTA) or net worth (pre-IPO).
- Taking the IPO prospectus at face value- Never take a prospectus at face value. According to the Australian Securities and Investment Commission (ASIC), approximately one-third of float prospectus were misleading to investors. When reading a prospectus, if we find that the projected earnings of a company seem to be ridiculously high in comparison to its recent history, we should be raising questions.
- Who are the ones exiting?- Especially when a listing’s owners are a private equity firm lining up to make their exit, we need to make sure that an IPO is worthy of investment and are priced attractively. It’s time to reconsider buying into a float when it appears that the people charged with turning a company around are heading for the door.
- Look at the big picture- It is essential that we look at all of the factors that are likely to have a negative impact upon a company’s business model and core earnings. What threats may be posed by future technology or new entrant disruptors? What will be the sources of future growth? What is the ‘defensibility’ of any existing competitive advantage?
- Being a healthy sceptic- The largest risks when buying into an IPO is what the company isn’t telling us. When looking into a company, it is our responsibility to identify what it is that his not being revealed to us. Warren Buffet, a famous value investor said, “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller to a less-knowledgeable buyer.”
Put another way, a company isn’t bringing a stock to market because they want to help us, their investors. They are doing it because they want to draw us in and have us put our money into their company.