Understanding a company prospectus
A company prospectus contains useful information about a company intending to list on the stock exchange, but it can be a difficult read.
Author
Jeff Long
Partner
- Details
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| Location: | Melbourne |
| Division: | Business Services |
| Publish Date: | 14/07/2008 |
A company prospectus contains useful information about a company intending to list on the stock exchange, but it can be a difficult read.
Often, it’s full of jargon that the average investor isn’t familiar with.
A prospectus is a legal declaration and must therefore include certain information in order to meet transparency standards. The trick is to distinguish between statements that would appear in almost any prospectus, and those that tell an investor the things that are most important about the company.
Some of the key areas to look at include:
Before undertaking an initial public offering (IPO), a business must undergo a thorough due diligence by a banking institution. However, investors shouldn’t be lulled into a false sense of security by a well-regarded name appearing in the prospectus. There are numerous examples of well-known banks supporting unsuccessful IPOs. Study the figures carefully and use common sense.
The intended use of IPO funds is always an important factor. If the funds are being used to pay out dividends to pre-listing shareholders, or the repayment of debt, new investors are paying for a company’s past and not investing in its future. It is far more comforting if a company has very specific ideas for the use of the money such as further acquisitions.
If a large number of shares on offer in an IPO are from pre-offer shareholders selling out, this is not a good sign because the company will not receive the expected funds from the IPO. Furthermore, if the prospects of the company are good, why are existing investors willing to sell their shares?
Look for strong revenue growth and consistent or growing margins. Revenue that is not growing (or is growing very slowly) is always a warning signal, unless there is an adequate explanation in the prospectus. Stagnant or declining margins are also not a good sign.
Over-reliance on a single customer or supplier is a significant risk factor. Loss of the major customer or the lack of alternate suppliers for key products can cause a company to fail.
Experience and expertise of the management team is very important in any business, and even more so during an IPO. Consider whether the management team is remunerated adequately, but with significant rewards in the form of additional stock. This means management will be rewarded in line with the shareholders being rewarded, so their interests are aligned.