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Current as of 22/10/14 06:40AM NZST

Tamsyn Parker

Money Editor for NZ Herald

How to read a prospectus

A beginners guide to decoding the important bits in the Mighty River Power offer documents

is expected to become one of the NZX 50's 10 biggest companies once it lists. Photo / Sarah Ivey
is expected to become one of the NZX 50's 10 biggest companies once it lists. Photo / Sarah Ivey

How a company makes its money and the risks involved are the two main points to focus on when reading through an investment prospectus, say finance experts.

The prospectus for Mighty River Power is already online and will be available in hard copy from Monday when the offer officially opens to investors.

The 250-page document has a lot of detail in it.

Massey University finance professor Jeffrey Stangl said people should let their common sense prevail when reading it.

"Investors should read the prospectus with a specific filter looking at the cashflows of a company and what the risks are to those cashflows," he said.

A company's value was based on cashflow and the surrounding risks, said Stangl, who holds an MBA in finance and is also a chartered financial analyst.

A major risk to Mighty River Power - the potential closure of the Tiwai Point aluminium smelter by majority owner Rio Tinto - has already been widely talked about. But it's not the only risk. The prospectus has 22 risk categories specific to the power company as well as general investment risks.

Nigel Taite, president of the Institution of Financial Advisers, said risk assessment could be pretty difficult for the average man on the street.

"Most individuals and most financial planners don't have all the skill sets required to make that assessment accurately."

Taite suggested getting professional help and said the cost of that advice should be included in weighing up the decision to buy the shares.

"For the average person who is going to put in a couple of thousand dollars getting advice from a stock broker will be adequate," he said.

"If you are looking to add the stock to your portfolio or need cash-flow then it might be better to see a financial adviser."

Taite said potential investors should also look closely at who the directors and management are and who to contact if something does go wrong.

He said the financial structure of the company was also important.

"How much debt does the company have? What is its current level and how much can they borrow up to without getting further approval from shareholders?"

Massey's Jeff Stangl said as well as looking at the company itself investors needed to compare it to similar investments to figure out if the company represented good value for money.

"They need to ask why Mighty River? Put it in context - how does it stack up with other companies that are largely comparable. Contact and Mighty River are pretty much apples and apples."

Comparisons are usually made using a price to earnings ratio which Stangl said was how many years of projected earnings investors were willing to pay for up front when they buy shares.

Based on the price range of Mighty River Power shares of between $2.35 and $2.80 per share and the forecast earnings the price to earnings ratio is between 20.5 and 24.4 for the 2013/14 year. That compares to a ratio of 19 for Contact Energy and 18.9 for TrustPower for the 2014 financial year.

Stangl said 24 years was a long time-frame to look forward into and a lot could change over that sort of period. But one of the other driving factors for people being attracted to shares at the moment is the higher returns when compared to banks.

Mighty River Power is offering a gross dividend of between 6 per cent and 7.1 per cent depending on what price the shares are set at.

Des Hunt, deputy chairman of the New Zealand shareholders association, said people should consider where interest rates were going when looking at Mighty River Power.

"Look at the dividends, make a judgment on how it stacks up, consider where interest rates are heading."

Hunt also believed in looking closely at the forecasts a company makes and comparing it to the historic performance to judge how realistic the company is being in making those predictions.

"When you buy shares on high price earnings with no growth you don't want them to have a bad result," he said.

"Have a look at what the growth prospects are or whether it is just a dividend play."

- NZ Herald

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