For quite some time we have been receiving queries regarding the IPO frenzy that has been going on in the markets. We have also been asked why we never recommend subscribing to any IPO. In this email we would like to share with you our thought process on why we usually refrain from investing in IPOs.
5 key points:
- Trustworthy Management – We believe that investing in a stock is no different than partnering with a company. Now if you are ever going to get into a partnership with someone, you would want that person to be trustworthy. We like to ensure that the company we invest in, and more importantly recommend to our valued subscribers, has a good track record. For IPOs we just do not have enough data and corporate governance track record to ensure these factors for our clients.
- Tempting Valuations – Warren Buffett once said, “The best thing that happens to us is when a great company gets into temporary trouble… We want to buy them when they’re on the operating table.” At Katalyst, we are always on the hunt for bargains that have huge upside potential and are yet to be discovered by the larger markets. These days IPOs are exorbitantly valued and have little room for error. The expectations regarding the company’s future performance are generally high and mostly factored in making it difficult for the stocks to outperform by a decent magnitude.
- Decision making during tough times – ‘When the going gets tough, the tough get going’. Most stocks perform well when the larger market sentiment is positive and the investors are overly optimistic. The true test of a company comes when the economy is under stress and the market sentiment is weak. It is the decisions that the good management take in the toughest times that separate them from the crowd. Performing well, consistently, over longer periods of time is what we expect from our partner companies. With the little data that is available of the IPO companies, it is close to impossible to understand how well the company would be able to handle an unforeseen scenario.
- Transparency and Connect – When a stock we invest in corrects 20%, it takes conviction to stay calm and, in some cases, invest even more. In order to build that conviction, we need something to hold on to. We need to have a thorough understanding of the business and its potential to perform as per our growth expectations. That level of understanding can only be built when the company is transparent and accommodating in its disclosure policies. With IPOs, we have no knowledge of the management’s attitude towards solving investor grievances and disclosing necessary data points.
- Accounting Practices – While we appreciate great stories and plans, we prefer that they are backed by numbers on the financial statements. If the logic works in theory but fails to work in practice then we must rethink the logic. And our favorite way of figuring out if it works in practice is by analyzing the numbers on the financial statements. It’s been our observation that the sales and profit numbers are generally inflated in the year the companies come out with an IPO and with inflated valuations, most of them become a strict no-no for us.
Due to the reasons mentioned above, we have never felt much need to participate in IPOs as there are already so many listed companies with 10-20 years of track record for us to analyse and invest in.
Our philosophy is to position ourselves to be lucky and that we do by looking for low-risk opportunities with significantly higher upside than what we are risking. The idea is to lose little in the ones that go against us against significant gains in the favorable ones.
Learn about our latest Stock Recommendation – Market leader, Double-digit growth, Covid-proof and Low valuations HERE