Investors need to understand how to interpret prospectus

Odhiambo Ocholla

The season of initial public offerings (IPO) is here with us, again. The last IPO was that of the Co-operative Bank, two years ago.

Despite the turbulent and bearish market, two IPOs-Transcentury and Britak-made their debut to the market last week. Most investors do not read the prospectus but it is very important. Reading long and tedious financial documents such as the prospectus, which is created at a company’s IPO is not very exciting.

But it can tell you a lot about a company’s intentions and future. Because the prospectus is a legal declaration and must meet transparency and disclosures standards set by the Capital Market Authority (CMA), most companies include certain facts and statements to ensure investors aren’t misled in any way.

For individual investors, the trick is to distinguish between statements that would likely appear in almost any prospectus and statements that tell you about the distinct qualities of a company. A prospectus is a written document that provides all material information about an offering of securities, and is the primary sales tool of the company that issues the securities.

It is also a legal document that protects the issuer or arrangers because it serves as written proof that you were given all of the material facts as they are set out in the prospectus. For that reason, you should be certain that you understand the disclosures made to you.

Think Behind the Numbers

Investors need to be assertive. Make sure that you are given a copy of the prospectus before you decide to invest and insist on help in reviewing the prospectus if need be. Be inquisitive. Ask every question about the offering that occurs to you. If you need to, make a list of your questions. If you cannot get an answer to your questions, do not invest.

Take time to read the fine print in the footnotes. There is "risk factors" section, which contains important information for investors. Read it very carefully. Keep your eyes open for contingent liabilities that could affect the company after you have bought into it. Every forward-looking figure in the prospectus is only a projection.

Therefore, there is no guarantee the company will meet all or even any of its targets for sales and profits. Because of the inherent uncertainty of these projections, investors must ask themselves whether they feel the assumptions are realistic. The dividend policy will reveal whether the share is income or growth oriented.

If income oriented, there should be a history of paying dividends. If growth oriented, there is generally no track record of dividend payments. Read report of independent accountants that is auditors’ opinion very carefully for any qualification relating to management reporting practices that do not conform to generally accepted accounting principles.

Read the section of top major shareholders very carefully which indicate the amount of ownership of the principals’ shareholders. If the company is not doing well and a number of the original investors are selling out, they may know something you don’t. Try to figure out how much money the founders and early investors contributed or paid to the company versus how much you and the new investors are being asked to pay.