Beware of the Inundation of IPOs

In times of a surging secondary market, as we witness today, numerous companies seek to raise capital from the public through Initial Public Offerings, commonly known as IPOs. In theory, this process is an effective means of aggregating modest sums that, when combined, hold significant potential to bolster economic activities such as establishing new facilities and offices, consequently fostering employment and contributing substantially to overall economic growth.

Yet, in practice, it has evolved into a different instrument, primarily employed by existing investors to exit at considerably higher valuations than their initial investment. Here lies the crux – the buoyant market conditions create an artificial frenzy, enabling these companies to offer IPOs at unreasonably high premiums. Individuals are enticed by these seemingly lucrative opportunities, witnessing some making quick gains. In reality, driven by greed, small investors often subscribe to various IPOs. A retrospective analysis reveals that in promising IPOs, small investors are seldom allocated shares, while in less favorable ones, they tend to receive more. Consequently, on a net basis, they emerge as losers.

Should You Invest in IPOs?

This begs the question – should one avoid investing in IPOs altogether? The answer isn’t a straightforward yes or no. It lies in between, within the realm of evaluation. Just as one scrutinizes prices when buying groceries like onions and potatoes, a logical evaluation process must be applied here as well.

Average Cost of Acquisition

So, how does one evaluate? Consider the acquisition price of existing investors, known as the Weighted Average Cost of Acquisition (WACA). This provides a fair indication of the price at which they originally invested and the price they now seek from the public. Noticeable disparities offer insight into the situation.

Avoid being swayed by future projections; instead, focus on past performance. If a company’s historical profitability record isn’t stellar, it’s unlikely to see a significant change going forward. Once the hype subsides, it will be just another listed company, with its price movements largely contingent on its financial performance.

IPOs: Monitor Performance

Investors should also closely monitor how the company intends to utilize the capital raised. If the use is stated as “general corporate purpose,” it’s a vague term that shouldn’t be wholly relied upon.

Another crucial aspect is the face value and price-to-earnings ratio. If a company is demanding a price-to-earnings ratio comparable to an established company, exercise caution. It took the established company years to attain that valuation; how can a newcomer expect the same?

Most importantly, there are numerous existing companies with much stronger profitability records available in the secondary market. Why not consider investing in those instead?

Consequently, investing in an IPO isn’t a guaranteed path to profit, and one should exercise prudence before making any investment decisions.

Wishing you prudent investing.

Disclaimer: The information and opinions expressed in this article are solely those of the author and do not constitute financial, legal, or professional advice. Readers are advised to seek professional guidance and conduct their own research before making any decisions based on the information provided.

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