After an extended lull in the initial public offering market, it is heating up again thanks to the highly anticipated deals by Arm Holdings plc. and Instacart. These will soon test out the waters. Warren Buffett, the legendary investor, has said that newly-public stocks may not be worth it. Berkshire Hathaway’s chief executive officer, who is known for his keen eye for bargains, believes that IPOs rarely offer good deals. Why? It’s because it’s almost never a buyer’s market. It is in the issuer’s best interest to choose a good time to list, while the deal with the special commissions is pushed for the highest possible valuation. Buffett stated at a Berkshire Hathaway shareholders meeting in 2012 that the idea that someone is bringing a product to market today and that the seller has the choice to decide when to bring it to market and that the security will be the cheapest to buy amongst thousands of companies in the world is nonsense. Charlie Munger, Buffett’s long-time business partner, said it more clearly: “The average buyer of IPOs will get creamed.” Both Buffett, and Munger, have described the underwriting fee that investment banks charge IPOs as “ridiculous” because they inflate IPO price. According to a PwC study of public filings by 1,175 companies, companies pay between 4% and 7% of the gross IPO proceeds. The smaller the company is, the more expensive the fee. Buffett stated that although it may not be the most appealing thing, people are excited by what is to come. Buffett has long been known to criticize investment bankers in Wall Street for encouraging deals that are more about generating fees than improving companies. Buffett usually avoids investment banks for his own deals. Berkshire, in its $11.6 billion purchase of Alleghany, last year, required that the seller pay Goldman Sachs advisory fees. The stock market is better in an auction market, says the investment icon. Here you can find bargains every now and then. The IPO market is more like a negotiated agreement where it’s hard to find cheap securities. Buffett used an analogy to illustrate why IPOs are not as attractive. He made the comparison at Berkshire’s annual meeting in 2004. He said that the houses in Omaha are a good example. He said that someone sold their home for $80,000, but their neighbor next door is not selling their similar house at $50,000. It just doesn’t work. They know how much it’s worth — and what similar properties are selling for. “That’s how negotiated sales work,” Buffett explained at the time. Buffett stated that if a bunch of entities owned 1% each of the houses in Omaha and there was a free auction market for these one-percentage stakes, then they could sell at “damn near anything”. He added that sometimes they can sell for crazy prices. In my opinion, you are more likely to find incredible bargains on an auction market. Buffett explained that it’s the nature of things. Buffett’s preferences Buffett studied at Columbia University under Benjamin Graham, the father of value investing. He has always preferred seasoned companies and avoided startups or companies that he didn’t understand. Berkshire has a wide range of established businesses. From its crown jewel GEICO Insurance to BNSF Railroad to almost 6% in Apple, Berkshire is a huge company. He also has a preference for family-controlled businesses, like Clayton Homes, because he believes that the management is a co-owner of the company. Buffett said that he invests in companies with a strong competitive position and earnings power in their industry. Buffett stated that it makes no sense to spend more than five seconds thinking about a new issue.
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