Should you buy into IPOs?

Initial public offerings (IPO) are a big moment in the life of a company, representing the transition from being owned by an individual or a small group of investors, to being publicly owned and listed on the stockmarket. For some companies, especially those in the tech sector, "going public" is the end goal, a way for the founders to sell up and reap the rewards of their hard work. For other companies, listing can be the best way to raise cash for expansion.

On paper, investing in IPOs can be a good way to make money fast. Figures from Renaissance Capital show that in the US in 2011 the average IPO stock rose by 10.5% on its first trading day, and two-thirds of such stocks made gains. The figures for the years since are even better. A larger study by Michelle Lowry from Penn State University of the 8,759 IPOs that took place between 1965 and 2005 found that the average return over the first month was 22%. Excluding the 1998-2000 tech bubble, the mean first-month return was a still good 15%.

There are a couple of problems, however. For a start, there are hundreds of IPOs in any given year. The practicalities of investing in them all, then "flipping" them on the first day of trading, would be beyond all but the most dedicated traders.

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Secondly, and more pertinently, ordinary investors rarely get access to the hottest IPOs before they start trading. Banks and underwriters try to sell the shares to institutions before anyone else gets a look in, often leaving retail investors with the unpalatable option of buying in only after the initial price surge. And that's rarely a good time to buy a 1991 study by Jay Ritter of the University of Illinois found that a spectacular first-day bounce is usually followed by long-term disappointment.

A notable exception is where the government privatises state-owned firms. Individuals are often actively encouraged to buy shares, and the government has every incentive to ensure that voters don't lose out in the short term after buying in. However, even then, access is tricky in the 2014 Royal Mail privatisation, two-thirds of all shares went to institutions.

If you're still not convinced, look at the Renaissance IPO exchange-traded fund (ETF). This aims to track the biggest US IPOs for the two years after they've first listed. The ETF has trailed the S&P 500 badly since launch in late 2013 (up 2% versus a near-25% rise for the US index). Treat IPOs like any other share: buy if you like the fundamentals, not because it's coming to market for the first time.