OPINION: The head of the new Catalist exchange for small and medium-sized businesses says there’s more to IPOs than ‘bargain hunting’.
Hot on the tail of respected financial adviser Brent Sheather’s column last week on why he thinks the public should steer well clear of initial public offerings (IPOs), I’d like to give another perspective.
To some extent, I agree with Sheather that some stocks tend to be overpriced at IPO but I believe there is another lens to consider: it’s not about bargain hunting, but rather focusing on considered long-term investing.
One of the problems cited with the traditional IPO market is that the same businesses (through broking and investment banking divisions) tend to act for both buyers and sellers. Given the relative fees they get from each side, the concern is these businesses might tend to favour the interests of sellers, meaning the IPO price is unlikely to be a bargain.
IPO prices are rarely bargains, although there are examples where investors have made large short-term gains as prices have shot up after an IPO. If the market did its job properly, the share price should fairly reflect the value of the business at the time a transaction is completed.
The problem is markets don’t always work perfectly.
Look for right ingredients
Investors buying based on the long-term fundamentals of a business shouldn’t be looking for bargains. They should be looking for a business they think has the right ingredients to grow at a good rate in the future and deliver acceptable return on investment.
The real advantage of an IPO is that an investor can get in on the first step of the company’s public growth ladder. The longer the time in the market, the better the chances of growth. It’s been said that it’s better to have ‘time in the market’ rather than trying to ‘time the market’ based on buying and selling at the ‘right’ time.
The focus on longer-term growth is the reason I don’t think investors on Catalist’s new SME stock exchange will prefer IPOs over secondary market trading, or vice versa.
Having periodic auctions of shares will help smooth out supply and demand. All the demand is condensed into those periodic auctions, which might happen just once every quarter or every six months. This means investors are incentivised to look at the longer-term fundamentals of a business, rather than trying to take short-term advantage of a perceived bargain.
While businesses completing mini-IPOs on this exchange will be supported by appropriate advisers, those advisers won’t tend to also be advising investors, so some of the perceived conflicts of interest are already addressed. All investors – from the professionals with close relationships with their brokers, to retail investors – can access it directly themselves.
We regularly remind our investors that investments in smaller companies can be riskier than investments in more established businesses, so they should always make sure investments in these businesses are part of a wider diversified portfolio. But getting in on an earlier step of a business’s journey can potentially lead to greater scope for growth.
Colin Magee is chief executive of Catalist, New Zealand’s stock exchange designed for SMEs.
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