18th September 2012
Mindful Money: With a number of high profile IPOs having disappointed investors, what are the pitfalls for a value investor?
Andrew Lyddon: Our approach, and I think it would probably be true of most value investors as it's a feature of the style, is that we like to do a lot of in-depth work on a company's financials, e.g. its balance sheet before we think about investing in it. Unfortunately one of the aspects of IPOs as they currently are is that the amount of financial information you get may be similar to what's in any other listed company's annual report but you only get maybe three years of it. So you haven't got the long-term track record to allow you to appraise how the business performs over a full economic cycle.
That's the main problem with it. Your ability to know how businesses performed in the past, both financially and also operationally, is often much less than it is for a listed business.
John Kingham: I would say pretty much the same. Except in the case of Direct Line, for example, there may be more information in the public domain because when you dig into RBS accounts they've got numbers for that part of the business. So Direct Line might be different from other IPOs such as Facebook where it's coming from private ownership and only listed for a short period of time.
The general point remains, however. With IPOs you are limiting yourself to a narrow set of data, which is potentially a bad idea.
MM: What have been the main concerns raised by the Facebook example?
JK: With something like Facebook the type of person who would have invested might not have been interested in the broader picture. For a number of them the idea was to grab hold of the coat tails of something that's going to take off for the prospect of quite short-term gains. In my opinion they're not really the kind of people who would be poring over the financial reports of a company but are more interested in speculative gains.
AL: The investment banks are just incentivised to get the deal done so they're not really that bothered about who the shares get sold to. There may be a preference from the seller for better quality institutional investors who are likely to be longer-term but at the end of the day the investment bank and often the current owners just want to get the thing done.
On that basis it's not surprising that you will end up with a chunk of IPOs going to people with relatively short time horizons.
MM: Has market uncertainty following the financial crisis placed a greater need for investors to scrutinise a company's balance sheet before investing?
AL: The first thing I'd say is just to recognise that the outlook for the market is always uncertain, it's just that at times investors are more aware of that fact than at others. Today the stock market is acutely aware of the uncertainties and things that might go wrong, whereas back in, say, 2005-2006 everything seemed lovely for investors and people weren't really thinking that the world had the potential to change very quickly.
If you approach things that way it leads you to focus much more on what you are paying for businesses and how reasonable that is. It should also make you want to ensure that businesses you invest in are financially robust in order to stand up to any future shocks.
JK: When we had a period of boom, which he had until recently, people think that these difficulties fall away and it becomes easier as all you need to do is buy something with ".com" in the name or buy lots of buy-to-let properties to jump on the trend. They often forget that trends can mean reverse or do other unpleasant things.
The complexity doesn't decrease. When the environment seems benign people just become lazy.
MM: Looking at some of the company results coming out, there appear to be a number of firms that are struggling in the current climate. Given constraints on the supply of credit, can investors still look at these companies as presenting value?
AL: As value-oriented investors you inevitably end up looking at the losers in share price terms because they are often the ones that will have the most appealing valuations. It's then a matter of balancing the risk of the weaker financial position that is causing the share price dip with the potential reward that comes with a more modest valuation. As ever you have to ensure that you're properly compensated if you are making a higher risk investment.
JK: From my perspective I'm always trying to look five years or more into the future. So irrespective of where credit conditions are today, if you take a longer term view of your investments you realise that whatever is happening today is likely to change in the future. It's difficult to accurately predict how credit conditions may change in the short-term and use that to try to gauge where share prices are going to go.
AL: As long as the financial position today doesn't create a short-term pinch point with the banks or debt investors then your view should be to the longer term. If it looks like the company can weather the current circumstances then value investors tend to focus on how a company would perform under a more normal environment.
MM: What role can the press play? Are they part of the problem or can they help educate investors about the prospects for a company?
AL: I don't think I've ever seen an article in the press predicting what a terrible failure or how overpriced an IPO is going to be.
JK: They seem to say that afterwards.
AL: Absolutely, as you saw with the Facebook IPO. In fact the press often says that the Facebook IPO was a failure, but that depends on how you view it. It has certainly been bad for investors who bought the shares but from the point of view that it was the investment banks' job to get as much money as possible for the owners it could be seen as a phenomenally successful operation.
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