May 30, 2006

Reading a Prospectus

Over the past few weeks, I have taken some fascination reading IPO prospectus'. It takes a long time as an average IPO prospectus for an equity investment has about 150-300 pages. Given the abundance free time that I seem to possess at my place, this does not seem to be a problem.

Obviously not everything is interesting and you can comfortably skip about 50-75 pages. However, the rest of the pages are interesting as they always give a wonderful picture of the company and the industry. It always tries to give you a feel that this is the company that will give you a 'ten bagger' or atleast a 'five bagger' (A 'ten bagger' is a term used for companies whose share price moves by 10 times, a term borrowed from one my gurus, Peter Lynch).

Most prospectus follow similar pattern of reading. This is extremely useful as one knows when to skip pages. I do not have any interest reading the general risk factors, endless repition of financial statements (which I shall comment upon later), statutory disclosures etc. We all understand that cigarettes are injurious to health yet it still does not prevent the smoker from enjoying his five minutes of absolute freedom.

Anyways, I enjoy reading certain specific sections of the prospectus. First, the industry - gives a wonderful picture, as always, the growth prospectus, how India is always in deficit of these basic requirements, commitments from the government (which I do not know if it will be implemented) to improve them which will be repeated from infinite number of times, outsourcing that will always happen to India and nowhere else. While it sounds pessimistic, I enjoy these statements because it tells me there is so much scope to improve in the country. Developed countries would face this biggest concern-the reason for government to spend hufe amounts of taxpayers money. India, being deficit in almost every area, has no problems. Outsourcing is a reality and cost savings are huge for companies. So, every prospectus reinforces the same issues.

The second part I enjoy reading is the company's prospects to grow in the near future. Most of them tend to be leaders in their category and almost all of them are planning to grow more than industry average. I do not know how everyone is growing at above industry average. However, this statement is something that one sees and cant help laugh at it.

The final part is the capital structure and what it intends to do with the money. This part is significant and it helps me to understand if the company is interested in building wealth to the shareholders. I like companies that repay its debt, however as far as it is above the cost of equity. As interest rates are low and most companies are 'leaders' in their industry this can't possibly happen. However, most companies seem to be expanding their capacities. Scalability will be important as companies can play with their cost structures effectively and hence gain advantage on pricing. What is most concerning is the kind of allotments the company has made in the past to its shareholders. Focus IPO for instance alloted at a steep discount to its preferential holders a year back but where charging the new investors thrice the comaparable cost. A comfortable exit option to the existing shareholders. I like reading the section that deals on civil and criminal suits against the company. Deccan Aviation tops this list. The suits against the company ran to three - four pages and it was fun reading the reports. This section is important as it shows light on the quality of management. However, the number of complaints is related to the industry, as a company that is in the end of the value chain is bound to face more. Directors of the company and their profiles is another good area of reading. Again Deccan Aviation tops in this. One of their directors is a director of 52 other companies too. If every company keeps atleast 5 board meetings a year, he will spend most of his official days just from one board room to the other. Something has to be done on this issue. You can't have directors, who are meant to safeguard shareholders interest being a director in so many companies. However this is India and as I said earlier, huge scope for improvement exists.

Finally and most importantly the current balance sheet, profit and loss and cash flow statements. This is something you will see frequently in the prospectus. Comany's projection seems to be there on every page of the prospectus, ( exaggerated but cant help myself). Yet reading this gives me an idea on whether to invest or not. Well, what I do like about these IPOs are that they do meet their projections in the near future once they are listed. As I do not track most of these companies post their issue, I do not know what has happened to their projections. My guess is that they should have met them as the stock markets seems to be quite embarrassed to list IPOs at par and most of them have done well even past a few quarters after their listing.

Currently I am reading a prospectus on Allcargo. Lemme see what fun this prospectus beholds to the reader.


Anonymous said...

As per SEBi Guidelines, no company can include projected numbers in their Prospectus. Can u share names of the cos that have done this? Thx-Sudhir

Anonymous said...; You saved my day again.