New issues

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8. What to look for in the prospectus (3) - blue-sky company analysis

What if a company has no earnings, and therefore no P/E or PEG? Then your task is immensely more difficult - some would say impossible. You are essentially in the position of a venture capitalist, having to judge the value of enterprises trying to break into untried markets, often with unproven products or technology. This, of course, pretty well describes the IPO boom of September 1999 to March 2000 in hi-tech and dotcom companies.

There are three main ways to approach the task of valuing such "blue-sky" businesses:

1. Be prepared for some highly challenging figure work.
   Some analysts and academics argue there is a rational method of valuation in these cases, but it depends on complex calculations, which are themselves based on untestable assumptions, e.g. about likely sales growth, profit margins etc.

   Critics say these assumptions are often so questionable that they render the calculations useless. On the other hand, the job has to be attempted in some form to value blue-sky companies for IPOs in the first place! For an example of how to do it, try the article by Professor Aswath Damodoran entitled "The Dark Side of Valuation: Firms with no Earnings, no History and no Comparables". Be warned: this approach is most definitely not money for old rope.

2. Rely on market sentiment.
   If there is no way to calculate blue-sky value accurately, then you will have to estimate investors' appetite for an IPO in order to judge how well it is likely to perform. Naturally, this is mere speculation. But provided you set clear exit prices for the profit or loss you will settle for, and are capable of controlling your emotions so that you do not get carried away with the crowd, you may be able to make this speculative approach work for you.

   One helpful guide to sentiment is the so-called 'grey market'. This used to denote the sharedealings that took place, strictly between professionals, before new issues came to market. These were based on unofficial prices, which indicated what City investors thought the true price was likely to be once dealings started.

   The term is now more often applied to the advance prices quoted by spread-betting firms. Private investors are free to bet on these, whether they apply for the actual shares or not. But they are not investing, merely gambling on what the market will do.

   If you have set your heart on a career as a stag, you should at least use their guesswork to gauge the level of support for a new issue before you apply. You can find grey market prices by following the financial press, or checking the firms' websites, e.g. cityindex.co.uk, igindex.co.uk, finspreads.com. Alternatively...

3. Forget it.
   Accept that seeking to make money from companies you cannot reliably value is no better than gambling. Stick to investing in traditional growth companies instead.

1. After Sid - a short history of the new issues market 2. Do new issues offer good value? 3. Types of new issue 4. Applying via brokers and intermediaries 5. The prospectus 6. What to look for in the prospectus (1) - directors and advisers 7. What to look for in the prospectus (2) - standard company analysis 8. What to look for in the prospectus (3) - blue-sky company analysis 9. Making your application 10. Stagging 11. A word on warrants 12. A tale of two issues 13. Conclusion

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