IPO prospectus generally average around 300 pages which consist of words and diagrams that provide you with all the info to attract your investment in them. But not everyone could find the time and the attention span to go through every page of the prospectus in detail and scrutinize every expect of the business.

 

In fact, some prospectus could amount to something like 500 – 700 pages depending on how big the corporation is. The bigger the business, the more info that it needs to provide to the public about its operating segments.

 

Since that’s the case, I’ve prepared an IPO cheat sheet that you could use in valuating any upcoming offering.

 

1. Check the industry

The most important thing to do before you even start turning the first page of the prospectus is to know the industry briefly. If we could steer ourselves away from a ‘sunset’ industry, we might have won half the battle.

 

If you’re still keen on investing in a company which you aren’t familiar with the industry, it’s not the end of the world. You could find some basic information about the industry included in the prospectus.

 

2. Basic IPO information

Basic information like allocation of shares is important for an IPO. The availability of shares on float would determine the trading liquidity.

 

If 30 of its substantial shareholders are holding to 95% of the total issue, the low liquidity in day to day trading might cause irregular spikes and drops for the share price. The best is still the mix of 70% substantial and 30% free float.

 

Beyond that, major IPOs would show you the allocation to institutional investors. These parties are heavyweights where they could leave an investment immediately at their will. You can expect stock price to trade at a higher premium if the percentage of institutions are more than its directors.

 

Common ones are Lembaga Tabung Haji, Employee’s Provident Fund or Khazanah.

 

3. Utilization of Proceeds

I believe this could be one of the most important information where every investor is interested in. Think of it this way, we want our investment to grow and the only way for our investments to grow is to grow the business itself.

 

Companies get money through IPO in order to grow its business. Most businesses could use debt financing but IPO seems to be a way to obtain huge amount of funds in a short period of time. IPO isn’t only quick but it puts the company’s name on news creating some ‘brand awareness’ to the public. It’s a form of free marketing for the company when it goes on IPO.

 

Finally, be very cautious with companies who take IPO proceeds to payoff debt. This is a common case in most IPO. It is best that only less than 30% of the proceeds went into debt repayment.

 

Some would state that it uses proceeds to increase working capital. This is also another way to say “use proceeds to clear off current liabilities” since…

Working Capital = Current Assets – Current Liabilities

 

4. Financials
Do a basic financial analysis like would you would do with most companies checking margins, revenue growth and the level of debt. This allows you to compare it with its peers to get an idea how others are doing.

You could estimate the Price to Earnings that your are paying for since you already have the ‘number of shares to be listed’ and the ‘profit attributed to owners of the company’ from the most recent financial year. PE is also a good way to know how ‘cheap’ or ‘expensive’ a stock is compared to its peers.

Like what everyone says, an alternative meaning to IPO is “It’s Probably Overvalued”, that is why we see companies going for an IPO when market is having a huge rally. Our aim is to buy something which isn’t valued at the expensive end.

Just remember to cancel out extraordinary items and if the profit after tax is unstable, find away to estimate using Profit Before Tax and put in a standard corporate tax rate to derive the Profit After Tax.

5. Understanding The Business Better
If all else checks out, it is best to go deeper in understanding the business better. Some business comes with its own uniqueness where the growth obtained over the years are highly attributed to its uniqueness. It could come from product, operations, people, partners and many other aspects. In similar ways, its like trying to identify a company’s moat.

Some companies have that in their prospectus and some don’t. But it is always good to know about these info.

6. What should you left out?
Well if you’ve came across any prospectus, you might find a lot of sections talking about risk. They tend be there just to tell investors the risk that the business faces. Even worse is that a conglomerate’s IPO have tonnes of risk to go through since they have several business section to address

I try to ignore this part since risk are always there. There isn’t a company that could be operating risk free. I would classify these as unforeseen circumstances but put faith in the the management to lead the company through a crisis.

Take for example, its pretty obvious that investing in an oil company would eventually face risk of commodity price decline, risk of foreign exchange and risk of probably refineries blowing up. Definitely not single person in the world wants a refinery to blow up (maybe ISIS do)  and if that really happens then a well managed company could weather off this problem having a good backup plan. The business segments might be designed in a way that it isn’t too reliant on the performance of one.

In conclusion, I find risk factors to be annoying and if something goes wrong, there isn’t anything that you could do to stop it. My thinking is that companies have that in their prospectus to avoid being sued in case something happens.

 

I believe that evaluating an IPO isn’t this simple but these are the most common things you should look at once the prospectus is in your hands. I really wish I could simplify this further into a simple checklist but similar to a business, one is different than the other.

Try to master these few things and see your valuation against the outcome of an IPO.

Happy Investing…