Why Clever Investors Should Follow the IPO Market

Lukas Hofer

The IPO market is gaining momentum. Just two weeks ago Ferrari announced an IPO. Now Neiman Marcus wants to go public. Both are big players in their respective industry.

If you don't know what Neiman Marcus does, just take a look into the wardrobe of your wife. Yes, they sell clothes. Check her shopping bills and you'll see what kind of clothes. Neiman Marcus is a luxury fashion retailer. Almost 40% of customers have a median household income of more than $200,000.

An IPO is one of the critical milestones in a company's history. On the one hand, going public grants access to an additional financing source, which is great if the company has many projects and a promising growth potential.

On the other hand, there will be more people having a stake in the company and the management has to take care not to send unfavorable signals to the equity markets. Pleasing shareholders isn't always easy, especially if business is not going well.

When a company goes public, there will be an offer price at which investors can buy. The question is, is that price higher or lower than the actual value of the company?

As is so often the case, investment bankers of course have their fingers in the pie. However, it's not like some crazy bankers are pulling any price out of their a**. No, they apply sophisticated financial models during their valuation process in order to arrive at the fair value of the IPO firm.

Did you get the irony? We all know it doesn't work like this. That “fair value” is not really “fair” and they often pull it indeed out of their a**, at least partly.

Usually, they use multiples valuation, discounted cash flow models or dividend discount models. Science has proven that none of these models is superior; all are equally biased. In the end, it depends on the information which bankers factor in their models. So they can influence the outcome of that “fair value” calculation quite a lot.

The thing is that banks have their own incentives. I assume that none of you really believes that fairy-tale anymore that bankers are 100% genuine advisers.

The business relationship between the client and the bank is mostly limited to the IPO event. However, banks maintain long-term relationships with institutional investors, because they hope to hook up at other occasions as well. Hence, banks have an incentive to keep IPO prices lower than the “fair value,” in order to kiss the a** of their buy side buddies.

So the “fair” value is mostly biased and on top of that, bankers apply a discount, which is often not fully recovered during the IPO pricing process.

That's why underpricing is very common, which makes IPOs attractive for investors. If a company is sold under its real value, the probability is high that prices will go up after the IPO. 

Regarding Neiman Macus, here is a word of caution: The management has filed with the SEC without any underwriters. Hence, they are not yet paying banks to advise them. This is very unusual. There could be two reasons for such a move.

First, Neiman is owned by Ares Management LLC, a private equity firm. They might have the guts to go for it alone.

Second, they might not seriously plan to go public. Filing with the SEC might be an attempt to reach out to potential acquirers. Take a look at their company history. In 2013, they announced an IPO but then the owners sold the company. That might be a dual track strategy? We'll see...

Read More on Funanc1al

Why Dividend Stocks Can Be a Great Addition to Your Portfolio

Lukas Hofer

You buy, the price goes up; you make money. You buy, the price drops; you lose money. It's that easy. No rocket science, quite simple.

We call the end result capital gains… or capital losses! It's the first thing most people have in mind when they think about stocks. Indeed, looking for capital gains is a great way to make or… lose money. However, it's not the only way, not by any stretch.

Have you ever heard of dividend stocks?

Imagine you buy a stock and money comes in, even if it loses in value. That would be great, right? It's like getting drunk without a hangover. Or eating cake without gaining weight…

Especially if you are retired and don't have an income any longer. Wouldn't it be nice to have a steady income stream without thinking about price developments too much?

Some people appear to fuel an erroneous perception of dividends. Contrary to common beliefs, companies don't pay out sporadic dividends – here or there – because they had an extraordinary profit this quarter or because they feel like being nice to their shareholders next. Usually, the management follows a well-planned dividend payout strategy.

Imagine a company pays out a dividend one year and then drops it the following year. The market would react immediately and assume the company is not doing well. Hence, investors run away, the price drops, the CEO gets a lower bonus and can't afford a new Ferrari this year. Poor him!

Therefore, companies try to keep their dividend policy steady or grow their dividends slightly with each installment. That's why dividend stocks can ensure a steady income stream, even if their prices fluctuate. And that's why they are attractive to long-term investors.

John Rockefeller said: “Do you know the only thing that gives me pleasure? It's to see my dividends coming in.” Of course, I think dividends shouldn't be the ONLY thing coming that gives you pleasure (I won’t go into the detail…), but they can definitely contribute to your personal well-being.

Just ask Dr. Google for great dividend stocks; there are a lot of these. Many are huge, well-established players, such as PepsiCo or McDonald’s, which offer dividend yields of around 3%. PepsiCo has grown its dividend payouts over the last two decades. Their smallest dividend increase was 5%. I'm not necessarily a big fan of their drinks, but their dividend is quite “delicious” and welcome.

Obviously, the dividend yield and its growth – or lack thereof – are not the only parameters you should factor in when you evaluate dividend stocks. It makes total sense to look at other criteria, which you would consider when you assess other stocks as well: earnings, revenue, leverage (debt), moat (competitive positioning), etc.

However, there is one variable that is especially important when you look at dividend stocks: Cash flow. Usually, when evaluating a stock, you would look at price-to-earnings ratios. In case of a dividend stock, the price-to-free-cash-flow ratio may make more sense. Dividends are paid out in cash. Earnings or profit, however, are a non-cash accounting metrics. Hence, cash flow is more relevant when considering dividend stocks.

In other words, free cash flow is cash that is available; dividends are cash that leaves the company. Earnings or profit, however, is not cash that comes in. In order to calculate profits, you would for example subtract amortization and depreciation from your earnings, because that's a cost. However, it's not cash “effective,” so it's not cash that exits the firm.

Looking at dividend stocks, you should ask questions like: How did the cash flow develop over the past few years? What percentage of the cash flow does the company pay out in dividends? Is the distribution rate too much of a burden? Is the dividend safe? What do they do with the rest of their cash flow?

Give it a thought. Some dividend stocks could be a great addition to your portfolio.

Mr. Share The Agonized Agony Aunt

Ezra White

In a world of financial uncertainty, it’s good to have someone we can trust for reliable (if somewhat irreverent) advice. Once more we turn to our resident agony aunt for help with our investment woes.

My friend says I should invest in oil because, according to him, it’s the perfect time. What’s best, olive or vegetable?

Your friend is a wise man; you are not. As it happens, this could be a great time to invest in oil (although, not the sort you drizzle on a salad) but it could also be a terrible time. The crude oil market is very volatile right now and in the last year or so its value has fallen by close to 50%. Investors have been getting on board throughout this time, taking advantage of the low price and expecting it to climb, but it has continued to fall. Whether or not its current price is the “rock-bottom” one is anyone’s guess, but it could be expensive to speculate. One way to go about it could be to start taking small positions in relevant energy stocks and add over time.

Should I care about what’s happening with the stock markets in China? I mean, I live in and invest in the United States, so why would it affect me?

Think of it this way. The recent cluster-f**k in Greece was enough to send the markets into a free-fall not only in Europe, but also around the world. Well, we’re getting carried away. It was not really a free-fall, was it? Nonetheless, stock markets were impacted worldwide. Greece may be the cradle of civilization and the home of incredibly original soccer, but it’s still a tiny country with a GDP that is lower than several US states. China, on the other hand, is a global superpower, the second biggest in the world – well, by some measures, the first. If we draw an apocalyptic comparison (which seems apt) Greece is a serious case of the sniffles, one that made several people feel ill and then (hopefully) disappeared, whilst China is the Black Death.

How do the commodity markets work? I want to invest in several kilos of grain but have nowhere to store the mess.

This is tricky, but interesting nonetheless. The commodity markets allow you to invest in a number of commodities, such as grain. These markets began as a way for farmers to sell their harvest to investors and in the early days they would actually deliver a bag of grain to the trading floor so that buyers could sample it. This was a slow process, but the buyers soon realized that certain global events affected the price of the grain they had just bought, giving them an opportunity to sell it on for a profit or loss. From this, an entire market was established whereby trades were a form of speculation, as opposed to an actual purchase.

If you invest in a commodity you are sinking your money into the hope that it will retain its value or increase it, at which point you can sell it. You have no physical investment, but you are taking a position on a virtual market that has been around for more than 100 years, and in a product that is a big part of the economy and human civilization. It’s not like investing in stocks, though. The shares investors own may appreciate over time as their enterprises conquer markets and grow earnings. Betting the price of grain, chocolate, wheat, gold or oil will go up (or down) is mere speculation, not an investment in a wealth-creating venture. It’s a trade, period. Care to flip a coin instead?

Read More on Funanc1al