According to Price Waterhouse Cooper’s report IPO Watch Europe, there has been a significant increase in initial public offerings recently. The report states that “Q3 2017 was London’s most active third quarter by volume since 2011,” raising €2.7bn. But not every IPO represents a good deal.
The chance to get in on the ground floor often seems like a great idea to investors who are afraid of missing out, but the exuberance caused by a rising market often leads a number of average companies to list while the going is good.
These three simple rules should help you side-step any poor performers.
Rule 1: You gotta have faith
Back in 2012, Facebook’s listing was billed as the investing event of the year. It seemed like every man and his dog was scrambling to own a chunk of their favourite social media site – and many intended to flip their small stakes for quick gains.
The excitement quickly evaporated as the stock crashed roughly 50% in its first few months. The shares have long since recovered, but at the time there was a palpable sense of panic among shareholders.
This famous example illustrates the dangers of buying into an IPO for quick profits. That’s gambling, not investing.
In my view, serious conviction in the business’s long-term prospects is a prerequisite before diving into any IPO. Those that held the faith are up about 360% now, while those who bottled it at the bottom lost half their initial investment. Ouch.
Rule 2: Beware massive yields
Nothing gets UK investors going like an outsized dividend yield. In my experience, we’re willing to look past all kinds of problems to get our hands on chunky payouts. Don’t allow this proclivity to draw you into poor investments, however.
Take Entu, which offered a blockbuster 8% yield when it listed. The company sold energy-efficient conservatories, doors, solar panels and other such items, but did not manufacture much themselves.
In short, it was simply a salesman for other companies. There seemed to be no barrier to entry for this sort of cold-calling organisation and profits seemed to be propped up by tax breaks.
The solar division took a hammering when these tax breaks were stopped. The division swung from a predicted £1.6m profit to a £2m loss rather quickly. The bad news has kept flowing since then. The shares were suspended on 24 August and had fallen to below 30p at the time, despite listing at 100p.
When buying a high-yielding IPO, be honest with yourself. Would you buy that company if the payout wasn’t so tantalisingly high? If not, I’d consider looking elsewhere.
Rule 3: Buy local
There are plenty of solid foreign companies on the FTSE 100 (think Shell) but in my experience, it is best to avoid foreign IPOs on AIM. The market is designed to facilitate easy access to capital for growth companies and has relaxed regulations as a result. This has led to investors being on the receiving end of wealth destroying and suspicious activities by the likes of Globo plc and CamKids.
If you are considering investing in a foreign company on AIM, ask yourself why this organisation can’t raise capital in its own country. If it doesn’t have a very good reason, perhaps you should avoid it.
Buffett's No.1 Rule
Of course, the above tips are designed to help you obey Warren Buffett's first (and second) rule of investing: Don't lose money!
Of course, there's an element of luck in this game and every investor makes mistakes from time-to-time. Learning from our errors is key, but learning from the mistakes of others is a preferable and more profitable option. With this in mind, we asked our top analysts what the most common investment mistakes were and compiled them in a free report.
To learn from others' financial misfortunate, click here. Perhaps it'll help you obey Buffett's primary rule.
Zach Coffell owns shares in Royal Dutch Shell. The Motley Fool UK owns shares of and has recommended Facebook. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.