The Best IPO Stocks and Value Investing

Here is some free IPO advice!

The best IPO stocks are those that have a strong financial history as a private company spanning a number of years. They are desirable investments from a value investing perspective.

Not too many IPOs share this characteristic. Hence IPO risks may be substantial.

What is an IPO, you may well ask? An IPO is an Initial Public Offering which is a company that is applying to list on the stock market.

Investors (but not necessarily all investors) are being offered shares at a start-up price.

A document called a prospectus is issued as part of the exercise to enable investors to assess the value of the offering.


Why Mention IPOs?

I mention IPOs, commonly referred to as 'floats', because you may be bombarded from time to time by advertising from stockbrokers (including online brokers and financial advisers) in the form of prospectuses about new floats that are about to come onto the market.

Free IPO advice is provided by some companies on the web about new IPO offerings being made.


What is My Attitude Towards IPOs?

I generally avoid IPOs and IPO investing.

Mainly because of the disadvantages, which quite often include having limited history of earnings capacity as a private (unlisted) company.

In this case, the IPO may be too high risk and its value may not be easy to assess.

New IPOs tend to be offered when the stock market is in a state of exuberance. A large number of IPOs on offer is a sign of a stock market heading in the direction of a large correction.

IPOs are likely to be more successful when investors are making large capital gains, and are less likely to be offered (and be successful) when investors are still licking their wounds after a stock market crash.

Buying an IPO needs to be weighed up against what other already listed quality stocks may be available at a fair price on the stock market.

As Warren Buffett has suggested ...

... THE CHEAPEST STOCK AVAILABLE ON ANY GIVEN DAY IS UNLIKELY TO BE A NEW FLOAT; OTHERWISE WHY WOULD THE VENDORS BE SELLING IT?

Small private companies applying to do an IPO launch on the stock market will have to incur substantial listing costs that may significantly affect performance or initial profits, as listing costs can run into hundreds of thousands of dollars.

The exception to my avoidance rule may be for larger companies that do have a history of financial performance as unlisted companies over a number of years.


Characteristics of Unlisted Companies Compared to New Floats

Consideration needs to be given to the different environment in which unlisted companies work compared to newly floated companies

For example, unlisted companies do not have to provide dividend payouts to a large pool of investors.

They can concentrate on longer-term objectives, and are generally more free to operate out of the public gaze.

Also, reporting requirements for unlisted companies are not as extensive, so their performance as a newly listed company may alter considerably as they come under greater public scrutiny.


Characteristics of the Best IPO Stocks

The best IPO stocks tend to have the characteristic of being very popular (usually because their previous financial history is well known and well regarded), and so they receive extensive coverage in the financial press.

This tends to ensure that the demand for the stock will be strong and hence the stock price will, in all likelihood, exceed the listing price.

For this reason, you may have difficulty in obtaining an allocation of shares - unless you have a habit of taking your stock broker out to lunch!

Of course, this assumes that your stock broker has been given an allocation to distribute, which is not always the case.

Assuming your aim is to follow a value investing approach rather than being a speculator, the best IPO stocks are those that you would still like to be holding in five years time.

But keep in mind that an historical analysis of IPO offerings (1970-2008) by Prof. Jay R. Ritter at the University of Florida shows that IPOs have underperformed other firms of the same size (market cap) by an average of 3.5% per year during the five years after issuing, not including the first-day return.

This suggests that you are less likely to beat the market than to be beaten by it.


Some Other Checks on New Floats

Some other questions that need to be considered about IPO stock include ...

  • Where are all the float proceeds going, to the vendors or the company itself?
  • Does the prospectus forecast significantly improved (unrealistic?) earnings into the future? If so beware!
  • Is the company in a 'hot' sector? The heat can quickly dissipate.
  • Have the vendors issued stock to themselves the year before the float? Work this one out for yourself!
  • Other evidence of the directors feathering their own nest that may be relevant include aggressive accounting policies, related party transactions, or large salaries paid to management.

In Summary ...

Checking out these questions make it more likely that I will choose the best IPO stocks if I am enticed to participate in IPO investing.


From a value investing viewpoint, the main consideration is whether this initial public offering provides sufficient information in the prospectus regarding its past financial history over a significant period of time.

This will enable me to evaluate whether this is a stock that I will most likely want to own in five years time.


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