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Did you buy one of these disastrous IPOs?

Credit: Alex Proimos

Among Foolish contributors, the consensus is often that investing in Initial Public Offerings (IPOs) is a high-risk venture. Members of various services have been recommended to invest in a carefully selected handful of recent IPOs and have done exceptionally well out of them so far – however successful IPOs are often the ‘exception’.

Many IPOs over the past few years, such as McAleese Ltd (ASX: MCS), Vocation Ltd (ASX: VET), Dick Smith Holdings Ltd (ASX: DSH), Spotless Group Holdings Ltd (ASX: SPO), and Nine Entertainment Co Holdings Ltd (ASX: NEC) have been awful for investors.

Some, like Orion Health Group Ltd (ASX: OHE), and Reffind Ltd (ASX: RFN) are unprofitable, and were always going to be volatile. Integral Diagnostics Ltd (ASX: IDX) was hit by unexpected government regulation, while other businesses like Vitaco Holdings Ltd (ASX: VIT) were hurt by sentiment even though performance has been solid.

The point is, buying an IPO is a process fraught with risk because you, the buyer, are under-informed and up against a highly informed seller who can be more motivated to get the best price for their investment rather than earn returns for shareholders.

Of course, for every loser there are winners, such as oOh!Media Ltd (ASX: OML), IPH Ltd (ASX: IPH), and Burson Group Ltd (ASX: BAP). If you can’t distinguish between the two prior to launch however, I recommend steering clear of the business entirely.

A rule of thumb suggests that shares have a ~50% chance of trading below their offer price in their first 12 months on the market, and the past few years have shown this to be broadly accurate.

With the advent of numerous retail brokers offering IPOs to investors, it’s easier than ever to invest in one – but unfortunately no easier to make an informed decision. If you are going to try your hand at IPO investing, here are three crucial things to look for:

  1. Who is buying, and who is selling (and why)?

Strong institutional interest can be a good sign, but far more important is to see whether existing shareholders are selling out most of their stake, and their stated reasons for doing so. Foolish Analyst Mike King pointed out a number of warning signs in this area with McGrath Ltd.

  1. Where is the money going?

This is straightforward. If a significant chunk of money is going to things other than the business, investors should be concerned. JC International Group Ltd (ASX: JCI) declared in its prospectus that of the $5 million minimum it would raise, one third ($1.7 million) would go to IPO-related expenses, $1 million would be spent on an office in Beijing, and just 28% ($1.4 million) would be spent on performance bonds to win new contracts. When a company is spending more than half its minimum raising on IPO expenses and a new office, that’s an item of concern.

  1. How’s the industry doing?

IPO sellers wouldn’t be the first to try to exit an industry before a major downturn. This can be a difficult question to answer, but one that is well worth examining by would-be shareholders before making a decision.

You could also try contacting Foolish contributors on social media (see below) – we cannot provide advice, but if we receive enough interest we could look at writing an article on a company’s prospects. The IPO must have a market cap greater than $40 million, and be likely to attract a significant number of household investors, who are our primary readers.

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Motley Fool contributor Sean O'Neill owns shares of Reffind Ltd. The Motley Fool Australia owns shares of Burson. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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