ASK CMMBWhat is an Initial public offering?

12.JAN.07

Question? I have heard about companies coming to the market with something referred to as Initial Public Offerings. What is this and can I invest?

Answer : An Initial Public Offering as the name implies refers to a company coming to the market for the first time to issue shares to the Public. This is usually done when the company has reached a level of maturity and profitability, which makes it attractive for investors to buy shares.{{more}} More often than not the company issues when it has achieved a profitable profile so the shares become highly demanded and the issue may be oversubscribed. Therefore investors who are not apportioned the full amount in the initial offering may be looking for shares in the secondary market. This creates pressure on the price to go up. As such investors in the primary issue may find the value of their shares going up in short order. As a hypothetical example, a manufacturing company’s IPO coming out this year can be sold in the primary offering at $5.00 per share. However, the price of the share will attain closer to $10.00 in the secondary market soon thereafter due to demand from investors who did not get shares in the initial offering.

However, not all IPOs trade up. Some may go flat or even trade down depending on the level of demand for the share. This will of course depend on the market’s perception of the company’s strength and viability and hence the prospects for dividends. Therefore talk to a qualified financial analyst to get some advice before investing.

Question? Borrowing money for clothing, vacation or consumer items is very tempting, but I remember being advised many years ago that it’s generally a bad financial move to borrow money for things that depreciate in value. Can you explain why?

Answer: The principle of only borrowing to buy things, which do not quickly depreciate in value strictly, applies to a firm. For example, if a businessman would like to borrow to expand his firm he would want the assets, which he purchases to retain their value sufficiently in order to generate sales and hence repay the full principal and interest payments on the loan over time. If the assets quickly depreciate in value or utility before the loan is fully repaid then the firm makes a capital loss on investment since the remaining balance on the loan still has to be repaid out of the businessman’s pocket. This is when value is measured only in dollars and cents.

For an individual, buying clothes or other consumables will always result in having to pay the loan long after the item has been consumed. This should only be done if the individual feels a sense of lasting value after consumption, which is itself a subjective thing. Therefore borrowing to buy clothes or to go on a vacation may or may not have be advisable depending on the individual’s psychological profile. Therefore, it is not possible to say a firm yes or no. However, more often than not it may not be advisable to borrow for luxuries you cannot afford out of your own pocket.