Big-name Floats Can Trap Small Investors
Sydney Morning Herald
Friday May 3, 1996
The romantic notion of owning a share of an Australian legend has lured many new investors into company listings in recent years and, with some big-name floats coming up, many more will be drawn to the sharemarket for the first time. But, as PHILIPPA TYNDALE reports, cold hard judgment, not sentiment, is required to evaluate the worth of a company float.
THE day applications for shares in the Sydney Harbour Casino opened, prospective investors lined the streets outside the underwriter, waving cheques in their hands.
So desperate were some to grab the stock that they paid first and read the prospectus later.
Although Sydney Harbour Casino rewarded investors by going on to do well in the share market (it was issued at $1.28, floated at $1.45 and is now trading at $1.96), the episode shows the power that marketing hype can have over investors, many of whom are new to the sharemarket.
It also highlights a trap that small investors can fall into. That is, putting their money into something they know little about, other than its name.
In the case of Sydney Harbour Casino, there was a widespread perception that "a casino makes money therefore it must be a good investment". Had they read and understood the prospectus, some may not have been quite so keen to invest, according to one analyst.
"People will queue up and not be aware of the risks involved in the sharemarket," says Mr Max Cunningham, a broker with Macquarie Equities Ltd.
Over the next two years, small investors will be asked to buy into some of Australia's biggest floats.
Household names such as Telstra, Commonwealth Bank, Ten Network and Colonial Mutual will be seeking to raise billions of dollars in Australia and offshore.
Others in the pipeline are Sydney Olympic Stadium, Aristocrat Industries, Smorgon Steel, National Mutual and possibly Ansett. There is a string of smaller companies planning to list.
With so many floats on offer, investors will have to be increasingly discerning. Recent history has shown that simply having a household name does not make a company a worthwhile investment - look at Sunbeam Victa and David Jones.
How does the small investor go about assessing a new float?
With any float, it is important to look closely at factors that may determine the future profitability of the company, such as the business the company is in, its competitors, earnings outlook, and the general economic outlook.
Mr Michael Heffernan, head of research at Shaw Stockbroking, highlights the need to think about the industry in which you're investing.
"The lesser known the industry, the more information you need to know."
Mr Stephen White, head of equities at Macquarie Investments, likens the evaluation process to employing someone.
A potential employer will generally seek out the references on a person's resume before employing them.
"To form a view on the company, people should go to other sources," he says.
But, without the back-office resources of the fund managers, the small investor can find information hard to come by.
Although a prospectus must comply to guidelines and, in theory, should have enough information for a reader to make a reasonable judgment of a company, it is not always the case.
Some contain the bare minimum required for compliance.
Finding information on a large, well-publicised float is generally much easier than for smaller floats that may not be as well-supported by institutions.
A first stop would be a stockbroker, who may have carried out an inspection of the company and formed a view on the float.
According to Mr Nigel Adams, an equities dealer at BT Securities Australia Ltd, you apply the same principles to floats as to any other investment. "There is no real difference between a float and buying a share in the market.
"Investors have to look at objectives, risk profile, and assess what they are prepared to lose," he says.
If the objective is to "stag", that is, to buy the shares in the issue and then make a lightning dash into the market and take a profit on the first day, the investor may be disappointed.
Some people say stag profits are things of the past. "My view is that now there are very few floats that roar up on day one," says Mr Heffernan.
One reason for the fall in stag profits is the growing use of the tender or book building process in share floats.
With book building, institutional investors bid against each other in the period immediately before the float.
The bidding war generally rewards the seller of the business listing on the stock exchange with a higher price. But the process removes a lot of the pent-up demand for stock, reducing the "stag" potential for small investors.
Last year, Qantas, Lihir Gold and David Jones all went through the tender process before listing.
The perceived lack of stag potential does not mean you should not buy in at the ground floor as a medium-term investor. "The days of big premiums are gone but there are still opportunities to make good money," says Mr Adams.
The medium-term investor can afford to buy into a float and sit on the shares, even if they are not immediately star performers.
Mr Cunningham gives the example of the high-profile David Jones float last year. Issued at $2, the stock is now trading at $1.89.
The company announced last week that it would not meet the projections in its prospectus, blaming a difficult period in the retail sector.
Although many investors passed up David Jones shares, those who invested did so on the basis of its reputation as a quality retailer.
"There is nothing intrinsically wrong with the company. Medium-term investors shouldn't be concerned about David Jones," Mr Cunningham said.
Provided the management of a company is sticking to the strategy outlined in the prospectus, then it should stay on track, according to Mr Cunningham.
People should be wary of outlandish forecasts and be careful of forecasts more than one year out.
"Every year further you get out there is a greater risk of something happening," he says.
A further consideration, but one that is hard for the small investor to evaluate, is the quality of the company's management.
A potential investor should be satisfied that the management is strong and that its experience is relevant to that company's business.
"It is no use a geologist running a goldmine if he's just looked at rocks all his life," says Mr Heffernan.
This can lead to the classic experience of companies coming up against operational problems because people don't have the necessary expertise.
It is also important that the lead broker to the float has knowledge of the industry.
If you're short of time, you can always rely on the old broking industry adage: if there are more than five colour photos in the prospectus, then forget it.
THE KEY FACTORS
Some of the main points to consider in a float:
* That the company is in a growth industry.
* Where that industry is in the economic cycle.
* Strength of management - does it know the business?
* How it compares with other stocks in the same industry (locally and overseas).
* Potential changes to government regulation that may affect the company.
* Company fundamentals - cash flow, gearing, P/E ratios.
* Which way is the sharemarket heading?
* Is it attractively priced?
© 1996 Sydney Morning Herald