Eye-popping IPO gains are the exception not the rule
Investors can be lured by the promise of outsized profits from market debutantes, but history suggests they should steer clear
IPO celebration: TrueCar employees mark its recent IPO by ringing the opening bell at the Nasdaq Exchange in Times Square, New York. Photograph: Andrew Burton/Getty Images
Initial public offerings (IPOs) can be a source of feverish interest, but are they a source of real opportunity? Or is there truth to the joke that IPO stands for “it’s probably overpriced”?
Certainly, investor interest has been rekindled of late. In the US, the number of IPOs in the first quarter was the highest since 2000, with proceeds raised almost triple that of the same period in 2013. In the UK, 105 new companies joined the London Stock Exchange in 2013, the highest number since 2007, and activity has been even more brisk in 2014.
Currently, over-50s insurer Saga is preparing a £2 billion (about €2.45 billion) IPO, while online outfits such as Just Eat, AO World and Boohoo. com have all listed in recent months. In Europe, IPO proceeds are up 250 per cent on last year.
Nervy Recently, however, investors have grown nervy. In the US, Twitter has lost 60 per cent of its value since peaking last December; last month, eight IPOs priced below company expectations, the worst run since 2004.
In the UK, AO World has lost 40 per cent since its February IPO; Just Eat is 30 per cent below its IPO price; Card Factory shares suffered a double-digit decline following its recent London listing, while Pets at Home and Poundland are also below their offering prices.
While retail investors tend to get swept up in the hype surrounding high-profile IPOs, value investors often steer clear. Warren Buffett, for example, has not bought an IPO in more than 30 years, saying: “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).”
Brokers point to examples like Microsoft – a modest investment in its 1986 IPO would be worth millions today – and Google, which has risen more than tenfold since its 2004 flotation. However, isolated examples don’t reveal anything; to properly assess Buffett’s caution, one must look examine the historical record.
Historical returns IPO expert Prof Jay Ritter has done just that, examining the returns of every US IPO since 1970. Typically, investors are left disappointed. Excluding first-day returns, IPOs have underperformed other firms of the same size by an average of 3.3 percentage points annually during their first five years. Marked underperformance was seen in each of the past four decades.