What should investors know about IPOs?

24 February 2014 05:39 am Views - 2782

What is a prospectus?
It is a formal legal document, which provides details about an investment offered to the public. It is important to read the prospectus because it provides information regarding the terms of the securities being offered as well as disclosure regarding the company’s business, financial condition, management and other matters that are key to deciding whether it is a good investment.

The CSE goes through the prospectus before it is released to the public. The CSE takes reasonable care to ensure full and fair disclosure of information in a prospectus. However, it is important to bear in mind that the CSE does not take responsibility for the accuracy of the statements made, opinions expressed or reports included in the prospectus. Moreover, the CSE does not regulate the pricing of the shares.

As per the listing rules enforced by the CSE, a prospectus will entail the following details.

• Declarations
• Underwriting/minimum subscription
• Corporate governance practices
• Takeover offers
• Financial information
• Information on stated capital
• Profile of the entity
• Basis of allotment of shares
• Particulars of shares for which application is being made.
• Corporate information which include the name of the company, auditors, manager to the issue, etc.
• Objectives of the issue
• A statement that the consideration for which the shares are to be used is for fair reasonable entities
• Cost of the issue
• Information on  the current directors
• Management and management agreements
• Taxation
• Litigation, disputes and contingent liabilities
• Reports by experts
• Inspection of documents
• Other requirements

What should investors look for in a prospectus?
General

• Locate the “proposed offering” size, which will describe the amount of money the company plans to raise. Even if you can’t learn the exact price per share right away, you should at least be able to get a sense of how big the overall deal will be.
• Look in to the dividend policy.

Risks

• Read about the competitive landscape for the company and its risk.
• Infer if there had been an allotment of shares prior to the IPO and the terms and conditions pertaining to the sale of those shares. At times existing investors could use the IPO to exit the stock by selling it to the public with a capital gain (if the issued price is higher than the price the existing shareholders brought it at). In such an instance the supply side will out do the demand and thereby pushdown the price of the stock. However, the situation will be different if rules are imposed to lock the shares for a certain time period (the directive issued by the SEC on locking).
• Compare the competitive position of the new issue with the company’s rivals. It’s not unusual for companies to provide data about the size of the market in which they operate and to disclose their market position in a prospectus. Once you learn who the competitors are, research those companies to identify the market leaders.
• Look for any red flags about the business, including any legal trouble the company may be involved in, which should be listed under the “risk factors” section of a prospectus. The company should also provide a sense of the monetary toll that legal actions can have on the business.

Financials

• View financial tables that disclose recent performance. At the very least, you should be able to see revenues produced over the past few years, expenditure, profits, etc.
• Categorize the various business channels from which the company generates its revenue. This information should be spelled out plainly in the document. You should be able to identify the source of the bulk of revenue in order to recognize the company’s core businesses.
• Find out if the company is profitable. This information should be available in the financial table and there should be details of net income. If the company has not yet achieved profitability, there should be some description of when the business is expected to begin earning profits.
• The prospectus will give out details on the net asset value per share (NAVPS). The NAVPS is calculated by dividing the total net asset value of the fund or company by the number of outstanding shares. It gives signals on the true value of the share. The NAVPS can be compared with the offered price and decided if the stock is overvalued/undervalued. Yet, bear in mind that it is one of the many methods that can be incorporated to calculate the intrinsic value of the stock.

Dilution

• Dillustrates the disparity between the price that investors are paying for shares in the company’s IPO to both the book value of such shares and the average price paid by existing shareholders that include founders, officers and early investors.

Management’s discussion and analysis

• Pay attention to information regarding the directors of the company.
• Investors should be critical when reading this section. It gives the management an opportunity to discuss the management’s perspective on the company’s financial condition, changes in financial condition and results of operations. This narrative section should provide investors with information to help them understand how and why the company’s financial results have changed over the time period and factors that management thinks might affect the company’s future financial condition or operating results.
• It is visible that the decision to purchase shares through an IPO is a decision based on precision and caution. All investors might not have the expertise to analyse a prospectus. It is advised that they take the assistance of independent bodies.

Should you invest in every profitable IPO?
As stated earlier, the post-war IPO boom witnessed investors eagerly investing in all the IPOs. It is not a sustainable strategy for normal investors. Ones investment in an IPO should be in line with the individual’s investment goals.

Never forget that it is an ‘offer’ made by the company. It is your call to pick it or leave it. The regulator and the exchange have done their duty of enforcing rules in order to create a regulatory environment required to make informed decisions. It is up to investors to maximize their opportunities within this environment.  
“The individual investor should act consistently as an investor and not as a speculator”

- Ben Graham