Canny View: Consider carefully before purchasing IPOs

The recent announcement by Hawke's Bay Regional Council approving to float a 45 per cent stake in the Napier Port on July 15 has stirred up a lot of interest. Photo / File

Initial public offerings (IPOs), particularly those involving familiar companies, often draw considerable attention from investors.

An IPO occurs when a former private business decides to take on external investors, either by having the founder sell some of their shares or by issuing new shares to raise money for expansions by listing those shares on a stock exchange or an over-the-counter market.

The hype in new IPOs continues to be huge. The recent announcement by Hawke's Bay Regional Council approving to float a 45 per cent stake in the Napier Port on July 15 has stirred up a lot of interest among many investors in New Zealand. The initial public offer of the unique piece of Hawke's Bay infrastructure will be listed on NZX (NZ Stock Exchange) in August and will include a priority offer for Hawke's Bay residents, non-resident ratepayers, iwi and port staff.

The appeal of IPOs is understandable, and you can easily get caught up in the story of innovation and disruption, but investors should carefully consider their options wisely before they jump in head-first.

As an IPO investor you are supplying capital to the economy which can help grow real businesses. You could be lucky and get to enjoy the dream of repeating the experience early Kiwi investors had with firms such as A2 Milk, Auckland Airport and Fisher & Paykel.

However, the biggest downside for the potential IPO investor is dealing with volatile price fluctuations along the way and it is not an exaggeration to say that there were many volatile periods, sometimes lasting for extended lengths of time. According to CNBC from 2000 to 2018, the six-month absolute and excess return for IPOs has been negative.

Just last month, New Zealand's first marijuana IPO, Cannasouth (CBD), was listed on NZX and sold $10 million worth of shares. This gave Kiwis a chance to invest in the R&D firm, but the stock first traded at 51 cents and last traded at 35 cents.

Nick Stewart

Of course, to the true long-term investor, this wouldn't matter as long as the look-through earnings kept increasing. Sadly, when you look at average investor behaviour, a lot of shareholders don't behave this way. Rather than valuing the business and buying accordingly, they look to the market to inform them. They don't understand the difference between intrinsic value and price.

Coca-Cola IPO History

The Coke IPO changed lives forever. One small town, Quincy, Florida, became the per capita millionaire record holder in the United States because the local banker named Pat Munroe convinced everyone that Coca-Cola was one of the greatest businesses in operation.

The banker realised that not only were the financial statements strong, but he also believed that the product was largely insulated from economic stress such as recessions and depressions.

He said even if you lost your house, your job, and were waiting in a breadline, if you came across a nickel, you might spend it on a glass of Coca-Cola; an affordable luxury that provided momentary pleasure.

A global asset management company reported that at least 67 Quincy residents called the "Coca-Cola millionaires" accumulated significant fortunes before passing those fortunes on to their children and grandchildren, in some cases through outright gifts and in other cases through the use of trust funds.

The brand power of Coca-Cola was and is, extraordinary. Here's the fun fact: Coca-Cola had gone public at $40 per share but a conflict with the sugar industry and its bottlers resulted in a 50 per cent crash shortly and reached $19 per share which means the IPO investor would have watched his/her Coke share fall 50 per cent within the first year of owning it! Now that's the challenging part of being an IPO investor – dealing with volatile fluctuations along the way.

Benjamin's view

Benjamin Graham, the father of value-investing and much of the modern sharemarket analysis, recommended that investors steer clear of all initial public offerings in his acclaimed book The Intelligent Investor. This book changed the lives of many – particularly Warren Buffett, who was one of Graham's students at Columbia Business School.

Graham firmly believed that during an IPO, the previous owners are attempting to raise capital for expanding the business, cash out their interest for estate planning, or any other myriad of reasons that all result in one thing: a premium price that offers little chance for buying your share at a discount.

Often, he argued, some hiccup in the business will cause the share price to collapse within a few years, giving the value minded investor an opportunity to load up on the company he or she admires. As even the Coca-Cola example proved, this often turns out to be the case.

We consider this advice to be wise, especially for long-term investors who should probably opt for a well-diversified portfolio and work with a qualified adviser who ensures your assets are secured and looked after.

Finally, some stats. More than 60 per cent of 7000+ IPOs from 1975 to 2011 had negative absolute returns after five years in the secondary market, according to a UBS analysis using data from University of Florida professor Jay Ritter.

Also, research shows IPOs, as a group, behave like small growth, low profitability, high investment stocks and under-perform relative to the broader market. They're already priced to perfection in many cases and initial trading prices typically exceed the IPO offering price.

Investors will likely be well served in the long run by adhering to evidence-based approach with discipline and diversity rather than speculation and narrative.

Nick Stewart is an Authorised Financial Adviser and CEO at Stewart Group, a CEFEX certified Hawke's Bay-based financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.

The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz