Investment Insider: Beware flotations at 'wonderful' prices

The only definite winner of Friday's Facebook float is likely to be Zuckerberg (AP)

A recent survey conducted among Motley Fool users ahead of the Facebook listing revealed that investors with less than one year's investing experience were twice as likely to invest in the flotation of Facebook as investors with more than 20 years of know-how under their belt.

Could this be a case of curmudgeonly, older investors being out of step with their more socially aware younger peers? I can't speak for other investors but the reasons for my cynicism are manifold. They stem primarily from trying to understand why a company would want to float in the first place. Knowing why a company wants to sell a piece of its valuable asset should help to sift flotation gems from duds.

A couple of good reasons to float include a need to raise capital to pay down debt or selling shares to finance acquisitions. Another good reason is when a company floats to gain ready access to funds to finance acquisitions later on. Those are notably good reasons. But here are some bad ones too.

I call the first of these opportunistic flotations. These include companies that come to market to cash in on investor sentiment. I also hear alarm bells when owners of a business make huge gains from a flotation. When I see that Mark Zuckerberg is reportedly planning to scoop around $1bn, equivalent to a year's profit for the company, I begin to wonder.

Another reason for my cynicism is when a company only has a short track record of success. It is then difficult for investors to gauge whether growth in the run-up to flotation will be sustained afterwards.

The hope is you can snap up shares in companies when they are still young and growing. But as Warren Buffett said: "It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

David Kuo is director of investment website fool.co.uk