It may not seem so, given recent stock market volatility, but now could be just the time to invest in some of the more promising new issues of recent months.
The reason? To get issues away successfully in the present market climate requires pricing that leaves more than usual 'on the table' for investors. If you choose carefully, investments like this can be extremely lucrative. Not only that, but recent market action has meant little appreciation in the share prices of most recent debutantes.
In an IC article about a year ago I described 10 secrets of successful new issue investing. Here is a brief recap.
The first point is that by opting for a new issue you are usually getting a company with no previous stock market history, and no past price action, technical analysis or disgruntled bulls and bears to complicate the decision making.
At times of market turmoil new issues are shunned. That creates an opportunity for investors able to spot the best candidates for future stardom. You can pick them up at attractive prices when the climate for smaller company investing does not look that promising.
One golden rule is to avoid bandwagons and 'me too' issues. Investors make money by spotting the next bandwagon before it starts up, not by jumping on board one that's already rolling. Oil and gas, mining, biofuels, and renewable energy are all examples of trends that have produced a flood of 'me too' issues in recent months.
An advantage of new issue investing is that there is a standard package of information, in the form of the admission document. This usually repays careful study and intelligent interpretation. In the case of smaller companies, the company broker may produce research. Information like this can usually be had from the company web site, or via its financial PR adviser.
Accounts need careful scrutiny. Often, all is not what it appears to be. Some new issues, particularly 'shells' and so-called 'buy and build' consolidation plays, might, for example, have accounting quirks and post-balance sheet events that lead to them being assigned the wrong value by the market. Care is also needed when interpreting historic information from previously private companies. This is because, in cases like these, profits may have been struck with an eye to minimising tax for the owners, rather than maximising profits for public shareholders.
Another rule is to remember that basic valuation yardsticks still apply. In other words, look for distinctive companies that have something new to offer, that are easily understandable, and that are modestly valued. The best yardsticks to use are price to cash flow, price to sales, and return on equity. It's worthwhile, on the whole, ignoring loss-makers. There might a rare exception when there is a very good reason for not doing so, perhaps if substantial profits look to be just around the corner for demonstrable reasons that are specific to that company.
Management shareholdings are another sign of a good company to back. The best ones are those where management have a significant chunk of their own personal wealth invested in the company. That’s to say, a percentage stake of 3 per cent or more, and preferably something appreciably more than this. Options awarded to management don't count.
And while it's good to back managers with an established track record, avoid 'one-man band’'companies run by a single dominant entrepreneur. It's also worth looking for companies with a solid base of bona fide institutional shareholders.
Finally, don't put all your eggs in one basket. There's nothing wrong with investing in smaller companies, but make sure that this isn’t all you invest in. Balance the risks you run investing in untried companies like this by having part of your portfolio in gilts and a blue chip index tracker. And within your new issue portfolio, don't concentrate your investment in just one sector. It's important to diversify.
