New issues and IPOs: a beginner's guide
Had you bought shares in Google when it launched on the stock market in August 2004, your shares would have increased in value by almost nine times in the following eight years. On the other hand,shares in Facebook initially plunged when it launched in May 2012, and didn't recoup the $38 price until August 2013.
The moral of the story is that buying shares on flotation is a hazardous business. Here’s our guide of things to consider when contemplating investing in new share issues.
Why are shares for sale?
The traditional initial public offering (IPO) is from a growing company that wants to raise funds for expansion, to increase its shareholder base or to enable it to use shares as currency for expansion. An increasing number of flotations, however, take place to enable the directors or private equity investors to realise some of their investments.
If it is the former, you need to assess the company’s trading performance, prospects and management in the same way as you would any other company, comparing it with others in similar industries and so on.
You should be far more circumspect if the float is to realise profits for someone else – and particularly if directors and backers are selling all, or a substantial part, of their holdings. They tend to be very good at judging the best time to sell and that is seldom the right time for outsiders to buy. A ‘lock-in’ period, under which management or founding investors have to remain on board for a time, is a useful safeguard, but if they have already made their fortunes, they may not be that motivated to keep striving with the same enthusiasm as before.
Stage of the industry
Google’s share sale came while the internet was enjoying spectacular growth, and it continued to launch new businesses following its IPO. Facebook had already become the dominant social networking site but, unlike Google, it had just one activity and took a relatively long time to demonstrate it could convert that into real and growing profits.
Its sale also came when technology companies were back in vogue and price/earnings multiples were looking stretched. Facebook thought it could command a premium; investors disagreed.
New issues are generally priced at a discount to the multiples of companies that are already trading, to compensate investors for the risk of backing a company without a track record in public ownership. These days, sponsors of the issue usually do extensive pre-marketing to gauge the price at which investors will be willing to buy the stock before they set the price. Even so, as Facebook demonstrated, they can get it wrong.
Attractions of company and industry
If you would not consider investing in companies in the same sector that are already trading, why would you contemplate backing the flotation of a new company? Is it any better than businesses that are already on the market?
What the prospectus says
These documents can run to hundreds of pages. Key sections include:
• the risk factors – have you thought of them all and how serious they are?
• directors’ background, shareholdings, contracts, lock-in periods and amount they are selling;
• financial information, including significant changes in accounting policies;
• major contracts, including those with banks and other lenders.
So many analysts will be linked to the sponsoring banks of large floats, and therefore banned from covering them, that independent research can be hard to come by. If there is any, it is worth reading to get an untainted view of the prospects. But analysts can get it wrong too, so make up your own mind about the issue’s merits.
Retail investors’ chance?
Many sponsors simply don’t bother offering shares to private investors, preferring to chat up a few large institutions. Those that are accessible tend to be the larger, better known, companies and so the pricing is likely to reflect roughly what it will trade at after the float.
We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.