Picking new issues

Unsurprisingly, the last 12 months have proved far from "bumper" for new issues. In fact, it's been about as far from a "bumper" year as it's possible to be - one of the worst years for flotations in a decade or more.
 
But that is past history. The recent surge in the market has brought something of a climate of 'green shoots' for new issues, and if the market holds up and sentiment remains buoyant, the issue market could restart in convincing fashion.
 
In these circumstances, investing in new issues could be the right thing to do. The wrong time to invest in them is ahead of a downturn: a recovery phase in the economy, however, modest, is a much better scenario, not least because issues will be 'priced to go', and those companies that are selected for a move to the public market are also pretty certain to have sound businesses.
 
That's not to say it's a good idea to leave things to chance. Rigour in selection always pays dividends.
 
One good thing with a new issue is that it has no previous stockmarket history. That means no technical history in the shares, no bad memories for analysts, and no disillusioned bulls or bears to complicate the decision making. A new issue is an opportunity to invest in a company with a share price history that is a blank sheet of paper.
 
A new issue's business is important. At times like this, businesses that have low gearing, that generate cash, and that have a unique aspect to their business are the best options. Bandwagons, 'me too' issues, loss making companies, mining and oil exploration new issues, and 'one-man bands' - though they can be profitable for a while - are best avoided if the investment is for the long term.

If I think of the long term winners that have passed through my own portfolio and which were purchased immediately after flotation, my mind comes back to companies like Halfords (HFD), Paypoint (PAY), and the patent attorney Murgitroyd (MUR).
 
The best bit about new issues is that the information available is much more plentiful and detailed than normal. The admission document in particular is usually a meaty document that repays careful study. Broker research and corporate presentations can also often be found on the company website at the time of the listing or shortly thereafter.
 
Accounts need investigation, however. Particular care is needed interpreting historic information from previously private companies. Private companies are generally keen on minimising tax for their private owners, and this often manifests itself in relatively low profit levels. Once a company turns public, the priority becomes producing a steady pattern of profits growth for shareholders.
 
New issues that result from 'exits' onto the stockmarket from companies that were previously the product of management buy-outs, or buy-ins, or companies set up as so-called 'buy and build' vehicles, often initially have accounts (particularly in the comparative periods) that can look odd, because of the nature of the financing arrangements under which they previously operated.

These arrangements often render traditional comparisons and growth calculations redundant or misleading.
 
Basic valuation methods still apply when evaluating new issues, with price to cash flow, discounted cash flow, return on equity, and price to sales all being important. It is also handy if the company has a natural competitor in the industry in which it is involved, to do comparative analysis of numbers like this.

A new issue may often emerge at a discounted rating to more established competitors. But smaller competitors can often challenge the bigger brethren, and the opportunity for subsequent uplift in the rating may occur.
 
It's also worth being on the look-out for companies whose directors have retained a significant stake in the company on flotation, and those that have significant backing from well-known institutional investors.

That fact that directors and large investors have a financial commitment to a company is usually an indication that they believe that the flotation will remove some of the constraints under which the company previously operated and that this could usher in a period of rapid growth.

Peter says

New issues can be high risk investments. But they can also generate excellent returns, if you get the selection process right. It's worth reviewing even a successful new issue investment after a year or so.

Sometimes an initial burst of success can be followed by share price stagnation and the company gets forgotten. Doing a repeat of the initial valuation exercise can be a worthwhile exercise. Beware companies whose shares drift down 15% or more from an all-time high, and pay close attention to the market background.
 
It is essential also to balance the risks you run investing in untried companies like this by having larger companies, index trackers and bonds in your portfolio. It's important to diversify. Treat investment in a new issue as you would an investment in any other company.
 
Finally, it is hard from private investors to get access to new issues. But, in a hesitant market, this is not too much of a disadvantage. Big premiums over issue price are less likely to occur, and in any case best avoided. Often a good new issue can be picked up at a decent price once the initial enthusiasm surrounding the flotation has faded.