Are IPOs a Good Investment?

The recent rash of Initial Public Offerings (“IPO”s) hitting the market have created quite some buzz in the news media. With the huge sums raised in these IPOs far outstripping last years’ averages, inquisitive investors may be wondering if IPOs are the next big thing.

To answer that question, let’s look at the history of IPO.

Origins of IPO

The history of modern day IPO dates back to the Dutch East India Company (Vereenigde Oost-Indische Compagnie or “VOC”) and the Amsterdam Stock Exchange founded in 1602, which offered VOC shares to investors who would bankroll the spice and slave trade voyages in return for a percentage of the profits, while the exchange served as a safe and regulated space where financiers can buy and sell shares of these nascent global enterprises.

These investments were speculative in nature due to the unpredictability of the spice supply and trade journey as well as competition from other players, and investors ran the risk of funding unprofitable voyages. Bonds were also issued to generate further investments to fund individual voyages, and the company paid a regular dividend ranging from 12 to 63% of its profits, much like how publicly traded companies operate these days.

At the height of the VOC’s success, it boasted 40 warships, 150 trading vessels, and 10,000 professional soldiers in its fleet, not including employees and subjects, and operated for nearly 200 years.

Bubbles and Busts

It’s worth noting that the VOC’s ships carrying tulip bulbs also contributed to the infamous ‘Tulip Mania’ – one of the most famous asset bubble crashes of all time that serves as a cautionary tale on the pitfalls of speculative greed, which saw its share price experience radical volatility spiking to 1,200% of the IPO price before plummeting to 300% due to the tulip bulb craze.

More recently, the Dotcom Bubble in the late 1990s is another cause for pause before rushing in on what appears to be the next big thing.

During the Dotcom Bubble, the tech-dominated Nasdaq index in the US saw a rapid rise in equity valuations and investments in Internet-based companies between 1995 and 2000. At the height of the bubble in 1999, most of the 458 IPOs launched in the year were related to Internet companies.

Investors were quick to pour money into start-up companies riding on the Internet craze, with companies going public without a sound business plan, product or track record of profits. When the bubble eventually burst in 2000, these companies quickly folded, going from having market capitalisations in the hundreds of million dollars to going under.

Companies built on more solid fundamentals such as Cisco, Intel, Oracle, Amazon, eBay and Dell which were driving organic growth in the technology sector took some damage to their market cap but ultimately survived the bubble.

Reason for the Rise in IPOs

IPOs have certainly experienced periods of uptrends and downtrends throughout its storied past, with 2021 coming to pass as a boom year with an increase in companies wanting to list.

This is to be expected after the deferments of IPOs last year, rolling over to 2021 to coincide with what was previously expected to be a period of economic recovery, coupled with new IPO valuations for companies that have shown resilience against the pandemic or stands to benefit from the post-pandemic’s new operating normal.

It is an indication of the confidence in the capital market as investment banks inject funds to growing companies to position for the eventual economic recovery, happening not just in Malaysia, but in more mature markets such as Singapore, Hong Kong, the U.S and United Kingdom as well.

Making Informed Investments

Against this backdrop, investors seem to view IPOs as a more secure investment vehicle to park their money against the unpredictable stock market given the rigorous vetting and valuation process the companies have undergone during the IPO journey.

But as with all investments in the capital market, investors must be cognisant of the risks in addition to opportunities involved and avoid falling for purely speculative or fad-based investing.

Each company is unique with its own set of pros and cons, and savvy investors should evaluate every IPO on its own merits.

The prospectuses for IPOs are a good starting point to understand the nature of the company’s business, its place in the industry value chain, and the financial position and projections for the company, to gauge its prospects.

Here are some pro tips for investing in IPOs, to ensure that investment decisions are made based on sound fundamentals.

Tips for Investing in IPO

• Always read the prospectus of the company and learn as much about the company as possible
• Select companies with a differentiated business model, competitive product or service, and a large / growing addressable market
• Ensure the company has an established financial and operational track record supported by an experienced management team
• Select an IPO with a strong and reputable underwriter / investment firm
• Beware of overly aggressive IPO pitches and look beyond marketing materials for objective research
• Consider waiting until the end of the “lock-up period” to determine if the company is a worthy investment

If you’re interested in learning more about the services that The Sea Capital offers, feel free to email us or drop us a message.