New issues

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2. Do new issues offer good value?

One man who would have seen the bias against private investors as a blessing in disguise was Benjamin Graham, the father of value investing. In The Intelligent Investor, he wrote:

"Our one recommendation is that new investors should be wary of new issues - which means, simply, that they should be subjected to careful examination and unusually severe tests before they are purchased."

"There are two reasons for this double caveat. The first is that new issues have special salesmanship behind them, which calls therefore for a special degree of sales resistance. The second is that most new issues are sold under 'favourable market conditions' - which means favourable for the seller and consequently less favourable for the buyer."

Others disagree strongly with Graham. They claim that new issues offer special opportunities for profits, because sellers are obliged to price them at a discount in order to 'get them away'. Unsurprisingly, many who argue this way are themselves involved in the IPO business.

As so often, it is possible to 'prove' either viewpoint if you select your statistics carefully enough. Graham looked at a sample of 41 new issues from the US IPO boom in 1960-62, of which 'five lost 90% or more of their high price, 30 lost more than half, and the entire group about two-thirds'. By contrast, one UK website highlighted the fact that the prices of new issues on AIM in 1999 rose by an average of 284%.

What seems to be true is that the quality of new offerings is highest, and prices keenest, in the early phases of bull markets. A key indicator of a bear market is that new issues dry up, because willing buyers have disappeared. As the economy picks up, the earliest companies to float may well be offered at attractive discounts and make excellent longer-term investments.

By contrast, the last fling of a bull market is always marked by a surge in the number of poor quality offerings as buying becomes indiscriminate. This is the time for you to heed Graham's warning.

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Quote

"The new issue market is ruled by controlling stockholders and corporations who can usually select the timing of offerings. Understandably these sellers are not going to offer any bargains. It's rare you'll find X being sold for half-X. Indeed, in the case of common-stock offerings, selling shareholders are often motivated to unload only when they feel the market is overpaying."
Warren Buffett

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