Should you join the Guzman y Gomez fiesta?

Last week, the publicity hype machine was set to “fiesta” mode with much fanfare over the Guzman y Gomez listing on the ASX.

However, investors should be wary of piling into initial public offerings (IPOs) because for every Nvidia, Google, Apple or Microsoft that turns out to be a big winner, there are thousands of losers.

Guzman y Gomez Co- CEO Steven Marks at the Guzman y Gomez floating at the ASX in Sydney.Credit: Dominic Lorrimer

Take it from someone who learnt the hard way, the cards are stacked against us retail investors.

Much unlike trading, where success stems from years of work and effort, success in the IPO game depends on your existing wealth and connections. It’s essentially a legal pump and dump scheme transferring the overvalued bags to the masses (you and me).

Warren Buffett himself has cautioned against jumping into new IPOs, warning “the seller decides when to come to market in most cases. And they don’t pick a time necessarily that’s good for you”.

“The Guzman y Gomez IPO will further cement the status of modern-day public markets as a Ponzi-esque wealth distribution mechanism for a privileged few and in many ways not much different to online gambling websites,” says Michael Hutchens, founder of financial modelling firm Modano.

Much unlike trading, where success stems from years of work and effort, success in the IPO game depends on your existing wealth and connections.

Indeed, the Guzman y Gomez valuation makes Nvidia’s valuation look cheap at price to earnings ratio of 500, compared with Nvidia’s 74. Yes, their breakfast burritos are great, but I doubt they are going to transform our lives in the way artificial intelligence will.

IPOs are meticulously orchestrated events, financial metrics are massaged to justify their desired valuation, and then they decide the price to list on the market. Overvalued IPOs are often offered to retail investors, such as you and me, at highly inflated priced during favourable market conditions such as we are in now.

“Initial public offerings” are anything but initially sold to the public. Access to shares is given to investment banks’ favoured clients, who can then sell their shares to retail investors on listing day for a guaranteed profit.

Benjamin Graham, regarded as the “father of value investing”, wrote in his revered book The Intelligent Investor that “IPO does not stand only for ‘initial public offering’. Rather it is shorthand for “It’s Probably Overpriced, Imaginary Profits Only, Insiders’ Private Opportunity, or Idiotic, Preposterous, and Outrageous.”

Last week, Guzman y Gomez shareholders made an instant 36 per cent profit when shares popped to $30. Earlier this month, analysts at Morningstar valued the stock at $15, 50 per cent below its current share price.

The company, which operates 185 stores across Australia and 210 worldwide, debuted with a market capitalisation of approximately $3 billion, the same as the ASX-listed Domino’s Pizza franchise, which operates 750 stores across Australia and 3844 across Europe and Asia.

Does it matter that the company isn’t actually of Mexican origin? Probably not, neither are burritos, margaritas or hard-shell tacos for that matter (sorry to pop your pinata). Just like the burrito, GYG’s founder is an American export.

What does matter is that an average GYG order costs 25 per cent more than an average order from McDonald’s, KFC, Hungry Jacks or Red Rooster. During a cost of living crisis, can premium fast-food outlets such as GYG really expect to open as many stores as McDonald’s as it hopes?

The Mexican-themed restaurant was worth $3 billion by the end of its first day on the ASX.Credit: Dominic Lorrimer

As a retail investor, you should avoid buying IPOs because there has yet to be a time for a period of “price discovery” or a trend to emerge. Buying an IPO on the day of listing means the market has not been able to do what its best at – establishing a price at which supply matches demand.

One of my biggest losses when I first started investing came from an IPO – a COVID-19 testing kit maker that listed during the pandemic and seemed like a sure-fire bet. But I got caught in the hype like I fear investors are today.

“Most of the high returns on IPOs are captured by members of an exclusive private club – the big investment banks and fund houses that get shares before the stock begins public trading,” wrote Graham.

So, while last Thursday was a Cinco de Mayo style celebration for the big end of town, for retail investors who followed the hype and bought shares on the day, it could be more a Dia de los Muertos (Day of the Dead) commemoration.

With shares crashing 7.5 per cent on Friday, the most since listing day, why not both, right?

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