The MUSCLE Method _®

Evaluating the Core Fundamentals

Evaluating an IPO’s core fundamentals is the last of the preliminary filters for analyzing IPOs. After looking at the state of the IPO Market, the Underwriter activity, the Strength of Industry and Core Fundamentals, you should have a good idea whether or not you will be interested in buying the IPO.

The idea is to go through the “MUSC” of the MUSCLE Method so you only have to look at the legal docs (step #5) on high quality deals.

Our philosophy is that fundamentals always win out in the end.

These are good indicators of the health of the company. How fast is it growing? Is the company profitable? How much debt are they carrying? While no single criteria qualifies or disqualifies any given IPO candidate, these metrics present an important overall investment picture.

The starting point for analyzing IPO fundamentals is figuring out what the company does. Look at our one-line business description at the top of every IPO profile. Read the prospectus summary found below it. Explore its corporate website. If you cannot understand the business, take a pass. Not being able to describe the business could mean you lack the technical background needed to intelligently invest in the IPO.

Once you’ve figured out what the company does, make sure you understand its business model. Where does revenue come from? What are the costs and mechanisms of delivering its products and services? Is it business-to-business? Business-to-consumer?

We’ve found that companies with the strongest fundamentals face a large, definable and growing opportunity.

They have a strategy for attacking the opportunity and a management team that is up for the task. They are typically the first movers and are actively erecting barriers to entry. Think Amazon.

There is a lot to unpack when looking at a company’s fundamentals, so we’ve narrowed our focus to 3 Core Fundamentals: growth, profitability and leverage.

Sales growth is an easy metric to analyze. Ideally, you would like sales growth to be more than 15% in the last year. This is a good indication of the health of the company. High growth usually indicates that they are in an attractive space or are taking market share from competitors. Declining revenue is a big red flag.

Profitability is the next core fundamental to analyze. Is the company highly profitable? If a company’s EBITDA margin is above 10%, it has proved that it has a viable business model. A profitable company is more insulated from disruptions to its operations and the overall stock market. However, it is not uncommon for strong IPOs to have low profitability, especially high-growth tech deals. So don’t necessarily rule out every unprofitable IPO if everything else looks good.

Leverage is the last of the core fundamentals to look at. How much debt do they have? If they do have a lot of debt (think 3x more debt than EBITDA) where is it coming from? Did a private equity firm pile it on before the IPO? Or have they used debt to invest in capex and R&D? Extremely high debt levels eat away at cash flow, and can even sink a company.

When you’re done looking at core fundamentals, and you’re still interested in the IPO, you can move on to analyzing the prospectus. Hopefully that document can clear up any remaining concerns you might have.