By Dennis Ng (guest contributor)
Successful Initial Public Offers (IPOs) such as Google might make investing in IPOs seem like a sure-fire way to make money. However, there are many IPOs that result in investors losing money as well. So what should you look out for to increase your chance of picking a winning IPO? Below are the criteria I use:
1. Proposed usage of funds raised from IPO
I am very wary when majority of funds raised through the IPO is allocated as such, for example: 80% is used to repay bank borrowings, another 10% for general working capital and only 10% for expansion plans. In such instances, the company is usually in a very weak financial position and is tapping on public funds primarily to improve their financial position.
2. Past financial performance
I look for consistency in growth, both in top-line growth (sales) and bottom-line growth (profits). There are some companies (I shall not mention names here) that opt to be listed after posting record performance in sales and profits, but subsequently, their financial performance began to go downhill.
For companies that have not reaped profits, their average margin on their revenue needs to be monitored. If the average margin is below 5%, you might want to give this IPO a miss, as it may take the company a long time before they can post any net profit.
3. Key financial ratios
I study key financial ratios like gross margin, net margin, return-on-equity (ROE), debt-equity ratio and average growth in sales and profits. When a company is not achieving any growth in sales and profits, the future share price will most likely be a yawn too…
4. Management team
How is the performance track record and experience of the management team of the company? Are they well-versed in their industry knowledge, or just regurgitating some pre-prepared script provided by their investment banker? Such insight can be obtained from media interviews, as well as press conferences when the management teams announce the launch of their IPO, etc.
5. Market sentiment
From time to time, I would still choose to adopt a ‘wait and see’ strategy even though I like a company very much. Why? Because if the stock market sentiment at that time is really bad, I do not have to risk losing money by applying for the IPO. Instead, I have the option to buy the stock from the market following its listing, at a cheaper price and also get the number of shares I desire!
6. PE ratio and projected PE ratio
Below are some questions I would ask myself before investing in an IPO. What is the historical price-earnings ratio (PE ratio)? What is the projected PE ratio for the next 1 to 2 years? How is the ratio compared to its counterparts listed in Singapore and other countries e.g. U.S.?
PE ratio is derived by dividing the price of the IPO by the latest earnings figure. For example, if PE ratio is 10, it effectively means that if the company continues to make the same profits every year, it will take 10 years before the price you paid for is equal to the earnings made by the company.
It is also important to compare the PE ratio of the company with its counterparts in the US and other countries. Why? This is because in today’s context, capital flows globally easily. If the share price of the company is deemed overvalued, compared to its counterparts elsewhere, then the funds may just buy into its counterparts, which are priced cheaper.
By guest contributor Dennis Ng, Director of Leverage Holding and Master Your Finance. Posted via www.MoneyMatters.sg, your guide on how to make more money, save smarter, invest intelligently, and enjoy your money like a pro. Click here to get our free report on what you must know about financial freedom.