A company that wants to expand its operations has a variety of funding alternatives.
One option would be internal company funds. Another option would be through loans from banks. Another option would be through an initial public offering, or an IPO, where shares of a company are sold to both institutional and retail investors.
In this regard, it is important for investors to realize that not all companies are the same and, therefore, not all IPOs are the same. There are things that can be considered to make the right choice.
Numbers matter. As a starting point, the company must be able to exhibit sales growth. A successful track record can give investors a glimpse of a successful future. Growing sales of a company can mean growing market shares.
However, the Boston Consulting Group model notes that it is not enough that company market share grows. The sector where it plays must be growing as well. Hence, a company that finds itself with a high market share in a high-growth sector is said to be a “Star” and so its IPO will be attractive.
Sales and shares are not enough. In analyzing numbers for a company, the use of financial ratio analysis to study the different business aspects will be handy. The first type of ratio would be the profitability ratio.
A company with healthy sales but with low or negative profit levels is still unhealthy. A good company is one that is able to consistently grow its revenues and manage its costs so that profits are maximized. An example of a profitability ratio is the profit margin ratio, which is the ratio of net income over total assets.
The second type of ratio is the liquidity ratio. This type refers to the ability of a company to meet its current obligations. An example of a liquidity ratio is the current ratio, which is the ratio of current assets over current liabilities. Ideally, the value must be at least equal to one.
The third type of ratio is the leverage ratio. This type gives a picture of how dependent a company is on debt. When things head south, settlement to creditors always precedes that for investors. A low debt ratio is thus attractive for investors.
The fourth type of ratio is the efficiency ratio. While there may be stock market analysts who do not put much weight on efficiency as a consideration, an efficient company may significantly reveal just how good a company is being managed.
One example of efficiency ratios is the inventory turnover ratio, which is the ratio of cost of goods sold over inventory. A high ratio number is attractive. Another efficiency ratio is the asset turnover ratio which is the ratio of sales over total assets. A high ratio number is also attractive.
Buying an IPO means that there is price involved. One important valuation ratio therefore that should be considered is the projected price-to-earnings ratio which is the ratio of the stock price over the earnings per share. Price-to-earnings ratios can vary widely across sectors.
Therefore, to assess whether a stock is overvalued, fairly-valued or undervalued, one has to compare the price-to-earnings ratio of the company with those of other similar companies in its sector. This will make the comparisons apple-to-apple.
Numbers matter but we need to go beyond numbers in analyzing the attractiveness of IPOs. The heritage and reputation of the company are important. The vision, strategies and plans of the company that are shared in the prospectus can determine if success will be sustainable or not.
The way a company handles poor economic conditions shows how resilient that company is. A company that is able to do well in terms of people, planet and profit objectives is a company that is poised to reap success over the long haul.
IPOs have various benefits to the economy. For companies, the additional funding can lead to accelerated investment spending that can spur economic growth. For investors, the right IPOs can provide financial gains through capital appreciation and dividends. These valuable gains can help achieve financial freedom.
Gemmy Lontoc is a registered financial planner of the RFP Philippines. To learn more about personal financial planning, attend the 87th RFP program this January 2021. To inquire, e-mail info@rfp.ph or text <name><e-mail> <RFP> at 0917-6248110.