Don't get sunk on new floats

By David McEwen

Monday 1st July 2002

Many investors are curious why the price of some newly floated shares rise strongly while others founder and even fall below their offer prices. We have seen both types of new listings on the New Zealand share market in the past six months.

Here are a few questions to ask that will to help sort out the potential star shares from the others.

- What are the vendors doing with the proceeds of the float?

If the vendors are raising new capital to finance expansion, then the company has a reasonable chance of showing strong earnings growth.

Strong earnings growth generally leads to higher profits and a rising share price.

If the vendors are selling out and banking the proceeds, then it's not such a good sign. The company does not have additional capital to expand and it is possible the owners believe there is only modest potential for growth.

- What is the track record of senior management?

History has shown that senior executives with a record of success in other companies are likely to repeat it. Executives that have failed in other companies have a habit of repeating their mistakes.

- What is the track record of the company?

Unless a company can show at least five years of profitable trading, it is hard to know how sustainable are its earnings and growth rate. Start-ups or overnight success stories might become consistent achievers but could just as easily be volatile. Investors can minimise their risk if they invest in companies with a record of rising sales, improving profit margins, and debt levels that are in line with their industry sector.

- Is the company cash positive?

The cash flow statement is often underrated, but it is there that the real story is unfolding. A company can be reporting a mountain of profit and yet be running deeply in the red in its operating cash flow (as did failed US energy giant Enron).

- Does the company dominate its market, or is it growing faster than others in its industry? Either factor offers confidence that the company can weather any unexpected business or economic storms.

- Are the shares fairly priced?

Some vendors try to get the absolute best price for their companies, but this can lead to shares being sold at high prices relative to the company's underlying value. In such cases, the only directions it can go after listing is horizontal or down.

Value can be determined by referring to numbers like the price:earnings ratio, dividend yield and price to net tangible assets. These figures need to be compared with those of similar listed companies. If the new listing is more expensive, the reason should be compelling before shares are bought.

- Are institutional investors taking an interest in the listing?

Institutional investors such as funds managers have good research departments and business contacts. They will make a decision on the attractiveness of a new float and, if they like it, will take up big parcels of shares in the offer. If they can't get enough, they will buy on the market when the company is listed, which can support the share price.

However, if they seem to be avoiding the listing, smaller investors need to find out why.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.

Comments from our readers

No comments yet