IPOs

An initial public offering or IPO refers to the process of offering shares of a private company to the public in a new stock issuance. An IPO allows a company to raise funds from public investors.

Although many studies show that IPOs in the first days show signs of better development than the market, they give poorer returns than the market over several years.

Tim Loughran and Jay Ritter have written in “Why Has IPO Underpricing Changed Over Time?” that the return on the first day (the share price at which investors were allotted shares measured against the closing price on the stock exchange on the first day of listing) was 7% in the 80s, 15% from 1990 to 1998, 65% in 1999 to 2000 before falling back to 12% in 2001 -2003:

In a student thesis from Copenhagen Business School, Fredrik Falck reviewed 117 IPOs from 2003 to 2012 which showed that they were underpriced by 3.1% from the issue price to the closing price on the first day.

While this is an excellent return, it presupposes that you are allotted shares before the IPO. But in the long run, unfortunately, the statistics have been reversed. Jay Ritter regularly updates data on this, and in his first research report from 1991, he concluded that IPOs did worse than the benchmark index over a period of 3 years.

He updated this report in 2011 which showed that IPOs averaged 7.2% worse than the market three years after the IPO.

Weak long-term returns are therefore hardly an isolated case. Why is it like that? IPOs consist of a number of companies that have a business idea that is often completely new and untested. Most fail or end up in obscurity.

Therefore, it is logical that many of these companies either go under or disappoint the market. Stock market introductions are often also high priced and are based on optimistic future calculations. If we also consider the small-cap effect, the long-term return will be even worse.