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1 reason most IPOs suck

Dick Smith store
Credit: hnnbz

IPO stands for Initial Public Offering. It’s the first time shares are listed (or ‘floated’) on a public exchange, like the ASX.

But if the ASX’s recently listed companies are anything to go by it may as well stand for Insanely Poor Opportunities.

Disaster IPO

Here are some of the recent IPOs to hit the market in terrible fashion:

Each company has had its share price hammered, or gone out of business altogether. Dick Smith was probably the most notable, given it was a retail facing business and its founder was an Australian icon.

It was also a disaster story for investors, like mum and dad’s, and their advisors. The company seemingly blindsided investors with working capital (that’s finance speak for ‘we stuffed up our cash flow budget’) and inventory issues.

But what really happened was investors were caught out by an informed seller. They took a perfectly healthy — but poorly performing — business, squeezed it for inventory and assets and propped up the profits before selling it to the market. Sure, it had a fighting chance, but only enough to meet some expectations.

The informed seller walked away with hundreds of millions of dollars.

1 reason most IPOs suck

The people (investment bankers) who conduct IPOs aren’t silly. They are some of the best analysts that walk this planet. That’s why most of them are paid $500k per year, plus bonuses. They know their accounting tricks, and most have experienced the emotional tops and bottoms of markets many times. They prop up company financials for a good time — not a long time — to get a good price and take home their six or seven figure bonus.

Fundamentally, they have a better chance of knowing what a company is worth than you, your advisor and your analyst.

They are privy to all the financial information and have endless access to management on road shows. In fact, there’s even a chance some of the bankers helped recruit and select the CEOs for the IPO spotlight.

Ultimately, they know more than you, a public company shareholder who receives two reports a year. Of course, if you sat down for a few hours or days (depending on how good of an analyst you are) and combed the Dick Smith financials, you could have avoided the despair.

However, you could have avoided the Dick Smith disaster altogether by simply refusing to buy into IPOs. 

Basically, if you take part in an IPO, you are buying from an informed seller whereas on the market it could be anyone — informed or otherwise. Do you think an informed seller would let you in on such a good opportunity or keep it for himself?

Foolish Takeaway

In my opinion, most IPOs are duds. And for the 5% or less that aren’t, they are so tightly held that the big institutional investors will crowd out your opportunity to buy.

In any case, so much of the time, it is like picking up a penny in front of a steamroller.

Warren Buffett, the world’s best investor and third richest person, was taught by Ben ‘The Father of Value Investing’ Graham. Graham believed an investor could use IPOs as a yardstick for investors’ emotion and, perhaps, when the market would likely fall. The further we go into a bull market, the more crap IPOs people are willing to buy.

I would go one step further than Graham and just avoid them altogether. If they are good businesses, they will still be around in one, two or even 10 years.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned. Owen welcomes -- and encourages -- your feedback on Google+, LinkedIn or you can follow him on Twitter @OwenRask.

The Motley Fool Australia has no position in any of the stocks mentioned. 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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