- Pick your key stats. The first thing I
always look at is in the financial table up high: Does the company have
an operating profit and, if not, are the losses growing dramatically?
Some companies go public with losses and do just fine; but more often
they don’t. Then I check revenue growth rates. Then, a bit further
down, I look at operating cash flow, and whether that’s growing.
- Compare new filings with old ones. The “risk
factors”, “legal proceedings” and “management’s discussion of
financials” are all important sections, but can go on for pages.
Comparing the most recent S-1 filing with the original will highlight
changes that were made in the interim - often at the request of lawyers
or the insistence of the SEC.You’d be surprised what can come out in
the highlighted text. I use Microsoft Word’s “compare and merge documents” command, which is kludgey but does the trick. If anyone has a better alternative, please speak up.
- Examine the margins.
Once a company goes public, investors will be scrutinizing whether
profit margins are rising or falling, so you might as well get a head
start. There is often a table listing expenses as a percentage of
revenue, letting you see in a few seconds whether costs are falling,
and whether margins are rising.If margins are falling, it’s not
necessarily bad. R&D or marketing costs might be up to plant seeds
of revenue growth. Look in the management’s discussion to see if you
buy the reason why. If all costs are up as a percent of revenue, that’s not good.
- Follow the money being raised.
This can be found in the “use of proceeds” section. It’s like the “how
I will change the world” speeches at beauty pageants. Normally a
company will say the funds will go to possible acquisitions and general
purposes like hiring and R& D. The more detail there, the better
the chances that there’s a focused strategy in place.Recently, some
companies have used most if not all proceeds from their IPOs to pay
existing investors a big fat dividend. That’s not necessarily a sign of
a bad company (VMWare did it) but if it happens with a company that has
a lot of other red flags in its S-1, it’s a clear warning.
- Check out the bosses’ pay.
Steve Jobs may draw a $1 salary and Larry and Sergey may insist on no
salary, but they are exceptions. Top executives at companies trying to
go public often draw between $200,000 and $350,000. Salaries above
$500,000 - and especially $1 million - can be a warning that managers
are only in it for the money. Look at the compensation tables in the
S-1.Another bad sign can be insiders selling the majority of their
pre-IPO shares, or insiders selling more aggregate shares than the
company itself is. Still another bad sign is an eleventh-hour plan to
issue millions of shares to board members and executives right before
the offering. These can be harder to spot.
And finally, a rough idea of potential valuation: Often the company
will put something like a “proposed maximum aggregate offering price”
on its first page to estimate its registration fees. Divide that by the
most recent 12-month revenue figure. If it’s more than 8-10 times
revenue, that’s not great. These help give me coarse picture in a few
minutes. Your mileage may vary.
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