If you don't trust the babysitter, then don't leave the kids with her. The same goes for company management. If you don't trust them, don't give them your cash. So when a company comes looking to you for cash, you need to be sure they'regoing to grow it for you, rather than just waltzing off with the money.
Ocado, the online grocery business will be coming looking for cash soon. From what I can see, it's a dud business.
If you invest in new issues, you need to be on the look-out for duds. I'd like to show you how you can separate dud IPO's from genuine opportunities. (IPO stands for Initial Public Offering - it's when a company first offers its shares for sale before it 'floats' on the stock market.)
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Don't be fooled by a slick sales pitch
There are accountants and brokers out there who'll set up businesses just to sell them to the public and tap investors for their money. These aren't out-and-out scams and that's why it's so easy to be deceived by them. There's always a genuine business, the only problem is it'll probably never make you any decent money.
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Before a company can float its shares on the stock market, it has to produce a prospectus. It's a kind of sales document, telling you how great the company is and how much it's going to grow and make you rich.
But you need to see through the marketing spiel to find out the real reason why these people are offering you a share of their business. The prospectus has the information, but you'll need to tease it out.
Remember, it's a sales document. It's not necessarily going to highlight that you're punting on a high-risk idea. It'll certainly not tell you that the management and their advisers will be quids-in, so long as you hand over your money.
Who stands to profit from the float
There'll be one or several investment banks that 'sponsor' the float, the City boys that organise the fund-raising and get the shares listed on the stock market. Take a good look at the sponsor's track record, and get a list of companies they've floated in the last couple of years. See how the stocks have performed. Look at the news stories. Make sure that they're dealing with genuine, profitable businesses.
Then if you're satisfied that the sponsor is legit, look at the management team. I want to see management that are from the industry the company's operating in. I want to know that this is their passion and they've been working with it for a while.
Avoid any business that's been set up by clever financiers to raise money from mug punters. Don't be fooled by 'big wig' City names with great CVs. These are exactly the sorts of guys most likely to be in it for themselves.
What do they want your money for?
Why does this company want your money? This is absolutely key. If it's for investing in a new exciting product, or for general expansion, that's great. But if the money's going straight into the pockets of the managers and advisers, I'd steer clear.
Be very suspicious if they're selling shares they've held for less than a year. See what they paid for their shares. If they paid 5p and are selling them for £1.00six months later, then ask yourself why.
I don't mind if management wants to cash in from a successful business that they've sweated over for years. But a company set up by part-time managers looking to cash-out having put in very little effort is a sure sign of a dud.
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Be suspicious if the money is for paying off debt. I've seen loads of IPOs based on businesses built on debt. It's quick and easy to create a business that shows decent cash-flow if you've got access to debt. In fact, you can even takeover an existing unprofitable business on the cheap, effectively 'buying-in' cash-flow.
It's easy to build up turnover. But it's profit we're after, and that's more difficult. They'll promise you that profits are just round the corner, but beware.
Once they've taken your money, they use it to pay off the company debt and yet, they still end up owning most of the company's shares, even though they've put in next to nothing. Oh and on top of that, management and their advisers get some very tasty fees along the way. Thank you very much!
Look out for this one
Ocado, the online grocery people, are looking to float soon. The prospectus hasn't been published yet [at the time of writing], so I can't comment on specifics. But there are some points that make me very wary. Management reckons the business is worth £1bn. Let's take a look at the facts.
Turnover last year was £427m. That's incredible. They're valuing their business at more than twice turnover. I'd like to see them defend that on Dragons Den! But it gets worse.
They have never made a profit! According to HSBC, Ocado may make £25m by 2014. That's a PE of 40x. This is a stratospheric valuation and remember, it's four years away! This business has been at it for ten years without a profit. What's to say it's even going to make a profit infour years time?
The money raised will be used for expansion and paying down its £100m debt pile. So your money is going to pay down all the debt they've built up during the last ten years. Great.
And then to top it all the management wants a £50m share incentive plan.
The business was set up by some smart ex-Goldman Sachs bankers. Now they're going to 'allow' others to get in on this fantastic opportunity too. I'm sceptical. And I'm not alone. Philip Dorgan, retail analyst at Ambrian, says: "Ocado starts with an 'o', ends with an 'o' and is worth zero."
I'll report more as and when the prospectus is available.
This article was written for the free investment email The Right Side. Sign up to receive The Right Side for free, and you'll be one of the first to see Bengt's analysis when it comes out.
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Theo Casey. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798. https://www.fsa.gov.uk/register/home.do
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