How to evaluate an IPO? Secrets of Successful Investing

 The IPO pricing model, developed by iFinik Investments, implies an assessment of a company entering an IPO according to the 10 most important parameters. Points are assigned for each parameter (from 1 to 5 star points). As a result, the company can score from 10 to 50 points. That is, the final score is comparable to the stars - from 1 to 5.

The assessment is carried out according to the following parameters:

1. Underwriters.

2. The product of the company and the level of "hype".

3. Growth in revenue.

4. Profitability.

5. Debt level.

6. Multipliers.

7. Market size.

8. Management.

9. IPO funds.

10. Allocation and Free Float.

Now about everything in order:

1. Underwriters. The level of the underwriter, his fame and authority, indicate the reliability of information about the company. As well as underwriters, one can draw a conclusion about the average yield of placements.

Little-known underwriters with a low average return of less than 10% over the past six months get the lowest score (1), and the "first tier" underwriters who have shown a return over 40% over the past six months get the highest score (5).

2. The product of the company and the level of "hype". The demand and relevance of the company's product during the placement period, the number of references to the company in the network are assessed.

Today's topical products are IT development and solutions, medical services and pharmaceuticals, products related to the electric power industry (electric cars, solar and wind power plants, lithium batteries), food delivery, smart logistics, etc.

3. Growth in revenue. The rate of growth of revenue is estimated, that is, the speed and scalability of the company.

And also, the dynamics of marketing costs in relation to revenue is estimated. Why is this indicator so important? There are companies that “pump” money into marketing comparable to their revenue, and in the absence of such expenses, there is simply no revenue ... Therefore, it is important that marketing costs gradually decrease, and revenue continues to grow organically!

If a company shows revenue growth of more than 50% for the last two years in a row, with a decrease in marketing costs (in relation to revenue), then it receives 5 points. If the revenue grows by 20-50% at least in the last year, then 4 points. If less than 20%, but still growing, then 3 points. There are companies that are in the process of developing their product, mainly biopharmaceutical companies and they do not have any revenue. The risk of receiving revenue in the future still remains a risk (the product may not be released, it will lose relevance, etc.), therefore 2 points. And negative revenue - 1 point.

4. Profitability. The level of profitability is assessed in terms of net and gross profit.

Profitability is the ratio of profit to revenue. Everything is simple here: if the gross profit margin is more than 50%, and there is a net profit, then 5 points (if there is no net profit, then 4 points). Since the IPO is mainly taken by companies that are just starting their development path, they do not always have a net profit. But if there is a net profit, then this is a big plus! If the gross profit margin is in the range from 20% to 50%, then 5 or 4 points, depending on the availability of net profit - is there or not, respectively. In all other cases - 1 point.

5. Debt level. The financial stability of the company is assessed. It's good if the company has no debts. After all, the higher the debt a company has, the higher the risk of default. But this is not always the case, because even with high levels of debt, a company can generate good profits. Therefore, it is the Debt / EBITDA ratio that is estimated, which shows how “easily” a company can pay its debts.

The lower the Debt / EBITDA, the better. If less than 1, then 5 points.

6. Multipliers. The position of the company in terms of multiples among other companies in the industry is assessed, that is, how much the company's multiples are higher or lower than competitors. The capitalization of the assessed company is calculated according to the data of the underwriters, as the number of company shares multiplied by the average value of the price band (estimated offering price). The main P / S and EV / EBITDA multiples are considered: the ratio of the company's capitalization to revenue and EBITDA. In rare cases, P / E is estimated (when the company is profitable for a long time). If we get multipliers comparable to competitors, then this is 3 points. If the multipliers are significantly lower than competitors, then 5 points, significantly higher - 1 point.

7. Market size. A company's potential in terms of revenue and position in the target market is one of the most important indicators. The most important are the so-called “growth stocks”, when investors assess the potential and growth rate of a company in terms of revenue. If the market is wide and revenues are growing rapidly, then the stock can also rise rapidly in value. But it also happens that when entering an IPO, the underwriters immediately evaluate the company by a value close to the size of the address market, that is, to the market share for which the product is oriented. Of course, in this case, the company has nowhere to grow.

The only problem is that it is not easy to assess the address market, and, as a rule, it is a highly estimated value, which depends on many different factors, which are simply impossible to take into account, or all the necessary data are not available in full.

So, if the market size is more than 100 times the current (annual) revenue of the company, then the company gets 4-5 points, depending on the company's ability to scale quickly (as indicated by the company's experience in increasing revenue). If the volume of the targeted market exceeds its revenue by more than 50 times, then the company receives 2-3 points. If the volume of the targeted market exceeds its revenue by less than 50 times, then the company receives 1 point.

8. Management. The business of a company is, first of all, people. Business development and IPO success depend on the quality of management. Management assessment is carried out based on the qualifications of management, the availability of specialized education or experience in the relevant field, management experience, as well as successful experience of selling a company or entering an IPO. If there is little information about management, or it is not disclosed, then 1 point.

9. IPO funds. The purposes of using funds are assessed. In addition, information on the sale of shares by existing shareholders plays an important role here.

As a rule, the public disclosure of information that shareholders are selling their shares during an IPO negatively affects the course of trading after the IPO. There are cases when this is not directly stated, but the purpose of using the funds is to pay off debts to shareholders, buy out companies owned by shareholders, or pay remuneration to shareholders (management), etc.

10. Allocation and Free Float. Allocation expectations and the number of shares in free float (Flee Float) are evaluated. The lower the projected allocation, the better: a low allocation indirectly indicates a high demand, although much depends on the size of allocation. As a rule, for small placements - $ 100-200 million, allocation is often low. However, it should be borne in mind that even with a high allocation and a large volume of placement (from $ 1 billion), upside can be good. One such example is the shares of Snowflake, which increased several times both on the first day of trading and after the lock-up period.

The higher the free float, the more points the company gets. Here we proceed from the assumption that with a small free float, stocks are subject to high volatility.