2 stock market newcomers I’ve got my eye on

There’s always a bit of publicity and excitement when a new company joins the stock market. But buying in the initial public offering (IPO), or when the shares first start trading, can often be an unwise move.

As Warren Buffett has cautioned: “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller [company insiders] to a less-knowledgeable buyer [outside investors].

We often — but not always — see share prices trading below the IPO level once the initial exuberance has died down. I’ve been keeping an eye on two promising companies that floated last year, and I’m wondering whether the time is now ripe to invest.

Rock on

Online musical instrument and equipment retailer Gear4music (LSE: G4M) had an IPO at 139p a share. The shares were lower for a spell earlier this year (dipping below 100p at one point), but have rocketed in the last couple of months and are trading at 330p as I’m writing.

Is this a missed opportunity, or do today’s half-year results from the firm suggest the rise is a mere overture to more substantial gains for investors?

The company posted revenue of £21.6m for the period, with the UK contributing £13.8m, up 44% on the same period last year, and Europe contributing £7.8m, up a whopping 169%.

Chief executive Andrew Wass said: “Trading remains strong heading into our important Christmas period and the board considers the group well placed to deliver results for the full year that will be ahead of its previous expectations.”

A report this morning from research house Edison (commissioned by Gear4music, so likely a good proxy for the company’s revised expectations) has a forecast for full-year earnings per share (EPS) of 7.7p, giving a price-to-earnings ratio (P/E) of 43.

The P/E falls to 29 next year on Edison’s EPS forecast of 11.4p (a 43% increase), producing an attractive P/E-to-earnings growth (PEG) ratio of 0.7. This suggests Gear4music could still be good value for investors today.

Pump iron

No-frills gym operator with the no-frills name GYM (LSE: GYM) had its IPO at 195p a share. The shares have since been above and below the IPO price but are currently trading at around the same level.

In its half-year results, GYM posted revenue of £36.1m, a £25% increase on H1 the previous year. Management said the group’s 80 existing sites are performing well and that its rollout of 15-20 new sites this year is on track.

Analysts are forecasting full-year EPS of 5.1p, giving a P/E of 38. This falls to 25 next year on a forecast of 7.9p EPS (a 55% increase). The PEG works out at 0.5.

GYM’s valuation is slightly more attractive than Gear4music’s, but when P/Es and earnings growth numbers are so high it’s not worth thinking in too precise terms. I’d prefer to say that the two companies have similar ballpark valuations — and that these valuations suggest both stocks are very buyable at current levels.

Small-cap winners

Gear4music was valued at £28m at its IPO but is now valued at £67m, showing how some small companies can deliver very large profits for investors in a short space of time.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.