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7 top tips for buying into an IPO

Tim Eisenhauer  |  30 Mar 2016Text size  Decrease  Increase  |  

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Tim Eisenhauer is managing director at OnMarket BookBuilds. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

 

Not all initial public offerings (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 Australian Securities Exchange (ASX).

As a general rule, investing in IPOs is a high-growth equity strategy. In fact, the odds of a positive return on an IPO investment were much better than average--last year, 59 per cent of IPOs finished the year at a price higher than their listing price while 6 per cent held their ground.

Indeed, if you had invested in every IPO on the ASX last year, you would have made 23 per cent by the year's end. The following seven tips will help guide you to a decent return.

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 good sign that management is motivated to do well.

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.