Leading small caps investor warns that a desire for short-term gain can lead to long-term pain
Joel Gray
“Rising equity markets have seen the tide of initial public offerings (IPOs) rise as success breeds success and more businesses consider listing, but the lure of short-term profit taking can lead to disciplined investment processes flying out the window.”
This is the warning from Joel Gray, Portfolio Manager for award-winning investment manager, Hyperion Asset Management, who today acknowledged that rising markets and the liquidity they provide do encourage IPOs, as companies seek to capitalise on positive market sentiment.
“Hyperion has a fund which invests exclusively in Australian small caps, so we keep a very close eye on upcoming IPOs, because small cap stocks make up the majority of the listings,” Mr Gray said.
“It is well-known that companies often list at an initial premium, so the temptation is certainly there to buy in at the beginning and take the short-term gains,” he explained.
Mr Gray said that rather than looking to profit from short-term price hikes at listing, long-term investors, like Hyperion, would do better to analyse upcoming floats in the same way they would any potential stock, with a focus on the fundamentals and a long-term horizon.
“The excitement which accompanies an IPO can mean investors become carried away with positive market sentiment and lose sight of the value of fundamental analysis.
“In fact, we see the recent spate of IPOs as a good test of whether a fund manager will stick to a disciplined investment process, or succumb to the desire for short-term gains,” Mr Gray said.
Hyperion’s investment process focusses on the long term and takes the view that high quality companies will outperform over the longer term, and that sustainable earnings growth is key to success. Ultimately this means investing in growing businesses with superior economics, at an attractive price.
Mr Gray said that the key factors Hyperion looks for are a high return on equity, a proven track record of success, low gearing and organic, sustainable growth.
“This naturally cuts out a number of companies looking to list. For some it is because the listing is based on a promise of future success, and without a track record to judge by, we take the view that no matter how compelling the promise, we prefer to wait and see,” he said.
Mr Gray then explained that of the more than 50 listings which Hyperion had analysed over the past 12 months, only two had been chosen – OzForex, which offers an on-line, cost effective way of transferring international funds, and VEDA, the largest credit rating agency in Australia and New Zealand .
“In the case of OzForex, not only is the return on capital high, but return on equity is in the order of 60%, the company is debt-free and sales are growing at 30% p.a,” Mr Gray explained.
“And perhaps more importantly, we predict high growth for OzForex, which provides a quicker, cheaper option for transferring money overseas than the major banks.”
Mr Gray concluded by saying that a buoyant IPO market can certainly offer a rich source of potential investment opportunities, but investors looking for long term performance should exercise caution.
“Long term success can only be built on rigorous analysis of a company’s fundamental drivers of success, regardless of whether it is about to list or is an established market participant,” Mr Gray said.