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7 ESSENTIAL TIPS FOR INVESTING IN IPOS

Posted by OnMarket 27 June 2018 @ 12:00am Investing Insights IPOs



Not all IPOs are created equal. If you’re going to put your hard earned cash
into the public float of a company, what are the markers of a good investment?
Below are seven suggested tests that you should subject any new issue to that
will hopefully put you on the plus side of the ledger when the shares actually
list on the ASX.

As a general rule, investing in IPOs is a high-growth equity strategy. The
OnMarket 2017 Annual IPO Report highlights the fact that the 113 IPOs to list
last year on the ASX returned an average of 61.6%. That is not a typo either,
yes 61.6%! This compares to an average return of 25.4% for IPOs in 2016. The
skill lies in selecting those companies that will outperform and obviously
avoiding the ones who don’t.

Here are seven essential tips that will assist you with your IPO investments.
They are must haves for your IPO selection check list.

1. WHO IS DOING THE SELLING?

Private equity IPOs follow the same rules as the rest of the market – though
they tend to be larger, in terms of performance they are a mixed bag with a good
to great chance of gaining in value.

However, after the Dick Smith disaster, investors will be expecting private
equity sellers to retain a larger equity stake (and to hold on for longer) than
in the past to insure against a ‘take the money and run’ scenario. So, if the
IPO is from private equity, ask how much of a stake they are retaining in the
company.

2. WHO IS GOING TO BE RUNNING THE COMPANY?

Take a close look at the lists of people shown in the prospectus as directors
and managers. The track record of those who are going to be in charge is vital.
Do they have prior experience in the industry? How long have they been with the
company? How much are they being paid? How well rounded is the board? And,
critically – do they have ‘skin in the game’? That is, is their financial
success tied to the company’s? If so, that’s a very good sign that management is
motivated to do well. If not – it is simple - stay away.

Keep an eye out for the less obvious. For example, some small companies combine
chief executive and executive chairman roles, which saves money but leaves a lot
of power with one person. Do your due diligence on them, including a Google
search and search ASIC’s registers for any suspect characters. One piece of
negative press may be a blip or a misunderstanding but several negative articles
may be a red flag.

3. WHAT ARE THEY GOING TO USE THE MONEY FOR?

Companies going public seek to raise funds from investors and there should be a
clear statement in the prospectus about how the money will be used.

You’ll need to investigate how the company will generate or expand revenues to
increase the value of the shares you are buying. How will growth be achieved?

Importantly, keep a sharp lookout for anything that will benefit third parties,
such as excessive fees being paid out to advisors, as occurs in some floats.

4.  DO YOU UNDERSTAND THE PRODUCT?

Investment guru Warren Buffett always says if you can’t work out what a company
is doing, stay away, as lots of other people will have the same problem. He’s
right.

It is simple yet integral advice, and something to keep a close eye on when
investing. Understanding the product may be particularly difficult when it comes
to technology stocks and their love of acronyms (anyone for SAAS, PAAS, or IOT?)

The lesson here is that if you don’t understand it then remember – it’s not you,
it’s them. Companies should be clear in the prospectus about what their product
or service is and why it matters.

5. HOW BIG IS THE MARKET FOR THE PRODUCT?

The size of the opportunity and the company’s ability to capture market share
can make all the difference when it comes to growth and shareholder returns.
Keep in mind that the size of the market is only an estimate based on many
assumptions. These assumptions need to pass the common sense test.

For instance, say a company is selling widgets and is targeting high-income
households. Consider how likely high-income households are likely to buy widgets
before accepting that the market size is equal to the number of high-income
households. Ask yourself, are there substitutes for their widgets? Is it a need
or a want? Would the product be better off as a Main Street or High Street
product? Do existing trends support the assumption that high-income households
will want to buy widgets or not?

Estimating the size of the market is a ‘best endeavours’ sort of thing but if
you don’t understand it or it doesn’t sit right, think twice.

6. HOW IS THE OFFER STRUCTURED?

If the size of the market looks promising, the management is experienced, and
the fees paid to advisors are reasonable, then it may look like a great
opportunity all round.

But if the offer is structured so that options, convertible notes or performance
shares will automatically be issued to the seller at a future date, this may
dilute your shareholding. Remember, each share you buy represents your piece of
ownership of the company. The more shares there are on issue, the less value
each one represents.  So it’s something you should investigate when deciding
whether or not to invest in the company.

7. ALIGN YOURSELF WITH AN IPO PORTAL THAT CAN PROVIDE YOU ACCESS

It is well known that retail access into IPOs, especially sought-after IPOs, is
very hard to come by. Therefore, it’s a good idea to find an IPO portal that
will bring you new and interesting IPO opportunities, and enable you to get a
decent allocation in the next great IPO.

The OnMarket IPO portal has been described as “the app making Australian IPOs
more inclusive” and the IPO platform “giving retail investors the chance to
finally get treated as equals”.

 

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