Response to the following problem:
New issues but old problems
It seems that we should be cautious when invited to subscribe to a new issue of shares arising from an initial listing on the Stock Exchange. The following extract from the Financial Times tells us why investing in new business flotations may be bad for our wealth. Back in 1940 Benjamin Graham and David Dodd, the fathers of security analysis, wrote: ‘the odds are so strongly against the man who buys into these new flotations that he might as well throw three-quarters of the money out the window and keep the rest in the bank.' Now confirmation of the poor record of recent new issues comes from an Ernst and Young survey. The accountancy group looked at the records of 200 companies that floated on the UK market between 1998 and 2002. It found that only 39% of the sample had increased profits since flotation (although 82% had seen their sales grow). This should not come as too much of a surprise. Companies are most likely to float on the market when their recent trading record is impressive. But periods of rapid growth can be very dangerous for a company - costs and management ambitions can get out of hand. Furthermore, no business can grow rapidly forever, and there is a risk that the flotation occurs just at the moment when the decline is beginning. And, as Ernst and Young points out, the very act of flotation incurs significant costs and can divert management focus from the business. The money raised can also burn a hole in the management's pockets, leading to a flurry of spending that would disgrace a football manager. All this is slightly discouraging, given that the primary role of the stock market is to allow growing businesses to raise capital. But perhaps a certain amount of investor greed (and gullibility) is necessary if industry is to gain access to finance. New issue investors have been fooled before; they will be fooled again.