Flotations are often overpriced and overhyped - it's best to ignore them

A good company can often be undone by a high valuation. Focus on the classic valuation measures. Take the most recently reported pre-tax profits, then work out how many times the total value of the company is trading as a multiple of those. Anything over 30 times and the company needs to grow very quickly which is very risky. Look for assets such as cash, property or equipment on the balance sheet. If things go wrong at least there might be something to sell and return to shareholders.

Ignore the majority of techniques used to support overvalued companies. During the dotcom boom in 2000, companies used anything from the number of clicks, to rapid revenue growth to justify wild valuations. The majority of them were laughable.

So, forget the celebrity endorsements, unique users and adjusted profits. Start down at the bottom of the profit and loss with reported pre-tax profit. The further you stray from those profits the further you fall down the rabbit hole into an accountancy wonderland.

Looking at the flurry of companies listing on the stock market there are plenty of warnings signs we are back in a bubble.

Just Eat is a website that aggregates takeaway services in one place. It is rapidly growing. The company has 40m users and operates in 13 countries with the majority of its revenue coming from the UK, France, Canada, Italy and Spain. The valuation is truly eye-watering. The IPO priced at the top of its range, valuing the company at £1.5bn and making it London’s biggest technology listing in eight years. It is worth more than The Restaurant Group, which made £73m in pre-tax profit last year.

Just Eat generated pre-tax profit of £10.2m last year, meaning it has a valuation of 150 times profit. The company raised £360m in gross proceeds from its listing but nearly three quarters of which, or £260m, will go to existing shareholders who are selling. Early investors SM Trust, Index Ventures, Vitruvian Partners, Redpoint Ventures and Greylock Partners are reducing their stakes from a combined 87pc to just 64pc. The racy valuation Just Eat has received brackets it as a technology start-up. However, the company admits that the ordering system and technology are not protected by any patents or design rights. This leaves it open to competition and relying on customer loyalty and agreements with individual takeaways.

This is only the most recent in a spate of wildly over-ambitious IPO valuations. AO World, the online electrical retailer, was valued at £1.5bn on last year’s pre-tax profits of £8.7m. Boohoo.com, the online clothes retailer for twenty-somethings, was valued at about £595m following its stock market listing. It recorded underlying earnings of just £3.9m last year.

When London-based games studio King Digital floated in New York it became Britain’s most valuable listed internet company worth $7.6bn (£4.6bn). The company is behind the wildly popular mobile game Candy Crush Saga. King Digital has seen profits soar from $11.1m in 2012 to $714m in 2013 but the problem is 78pc of revenues come from just one game – Candy Crush Saga. These games can rapidly fall out of favour, resulting in revenue and profits falling quickly.

If King Digital is to become a long-term prospect for investors then it has to show it can repeat its early success. There are plenty of examples of what happens if it doesn’t develop new games. Zynga was a profitable four-year-old games company that generated 92pc of revenue from Facebook. Games such as FarmVille and Words with Friends proved extremely popular. The company listed for $10 a share in late 2011. However, 12 months later the shares were trading at about $2.50, a painful 75pc loss.

It is worth comparing these tech stocks with the flotation of Royal Mail last year. It was a company being sold by the Government, which wanted its shares to rise, with prime London property on the balance sheet and a monopoly market position delivering mail and parcels in the UK. When it comes to stock market flotations, Royal Mail was the exception, not the rule.

There are signs that, while the bubble may not have burst, it is certainly leaking. Twitter floated last year valuing the messaging service at $31bn. However, it has seen its shares slump by 29pc so far this year. Now trading at $43.1 the shares are below the level retail investors could first buy them. Twitter may have had an IPO price of $26 but only a select few professional investors got access to that price.

For retail investors the best thing to do with the majority of IPOs is simply ignore them. They often come overpriced and overhyped. The banks and advisors running the process are incentivised to make the most money possible for the company, not investors.

Caveat emptor, buyer beware.

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