Following a column by respected financial advisor Brent Sheather last week on why he thinks the public should avoid initial public offerings (IPOs) I would like to give another perspective.

To some extent, I agree with Sheather that some stocks tend to be overvalued during the IPO, but I think there’s another goal to consider: it’s not about not to hunt for bargains, but rather to focus on a long term investment.

One of the cited issues with the traditional IPO market is that the same companies (through brokerage and investment banking divisions) tend to act for both buyers and sellers. Considering the relative fees they charge on either side, the concern is that these companies might tend to favor the interests of sellers, meaning the IPO price is unlikely to be a bargain. .

IPO prices are rarely a bargain, although there are examples where investors have made large short-term gains as prices have skyrocketed after an IPO. If the market has done its job correctly, the stock price should accurately reflect the value of the company at the time a trade is closed.

The problem is, markets don’t always work perfectly.

Look for the right ingredients
Investors who buy on the basis of a company’s long-term fundamentals shouldn’t be looking for good deals. They should look for a business that they believe has the right ingredients to grow at a good rate in the future and provide an acceptable return on investment.

The real benefit of an IPO is that an investor can take the first step on the company’s public growth ladder. The longer the time in the market, the better the chances of growth. It has been said that it is better to have “time in the market” rather than trying to “synchronize the market” based on buying and selling at the “right” time.

The focus on long-term growth is why I don’t think Catalist’s new SME exchange investors will prefer IPOs to secondary market trading, or vice versa.

Periodic auctions of shares will help smooth supply and demand. All demand is condensed into these periodic auctions, which may only take place once a quarter or every six months. This means that investors are encouraged to look at a company’s long-term fundamentals, rather than trying to profit in the short term from a perceived good deal.

While companies conducting mini-IPOs on this exchange will be supported by appropriate advisers, these advisers will not tend to advise investors as well, so some of the perceived conflicts of interest are already addressed. All investors – from professionals with close relationships with their brokers, to retail investors – can access it directly themselves.

We regularly remind our investors that investing in smaller companies can be riskier than investing in more established companies, so they should always ensure that investments in these companies are part of a more diversified portfolio. But entering an earlier stage in a business’s journey can potentially lead to more room for growth.

Catalist CEO Colin Magee.

Colin Magee is Managing Director of Catalist, the New Zealand Stock Exchange designed for SMEs.

This is content provided not ordered or paid for by NBR

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