Want to lose all your money? Invest in an IPO

If you feel yourself getting swept up in the excitement of a new disruptive stock coming to market, watch out. Buying into an IPO nearly always involves losing money, says Merryn Somerset Webb.

Uber IPO on the New York Stock Exchange  © Michael Nagle/Bloomberg via Getty Images

The idea that the majority of the companies you know by name will disappear within a couple of decades is now standard stuff.

In this view, our oil companies will soon vanish under climate pressure and the rise of solar energy. Our retailers are barely breathing and regular car-makers are likely to buckle under the better technology (and more creative thinking) of the Teslas of the world.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Given the brilliance of the new, it is tempting to ignore the giants of the past when investing. But should you be so dismissive?

With that question in mind, Verdad Capital, a US investment group, has looked at exactly what happens when you take that temptation to extremes.

Advertisement - Article continues below

Steer clear of shiny new listings

If, as a reasonably long-term investor concerned with avoiding the permanent loss of capital, you were given the choice of investing in a high-growth and exciting technology initial public offering (IPO) or in a long-established company with what looks like a bit too much debt and whose best days appear to be very clearly behind it, the odds are you will choose the IPO.

After all, high-debt companies with shrinking markets are unlikely to see much upside and come with the heavy risk of 100% downside via bankruptcy. That surely makes them best avoided.

Not so fast, says Verdad. It turns out that the easiest way to lose nearly all your money is via IPOs. There have been a lot of IPO losses in the past year or so, including Blue Apron, Uber, Snapchat, Pinterest, Aston Martin, Peloton and Lyft. And there are likely to be a lot more. Only on Wednesday, Uber shares fell to their lowest point yet: $26.05 versus a float price of $45.

The interesting point is that this is not a recent phenomenon. Verdad ran the numbers and found that of the last 3,700 IPOs since the late 1980s for which data is available, the median one lost 31% of its value from the close price on the offer day to three years later. Over five years, that number was 41%. Not all growth stocks grow enough to justify growth valuations (or at all, for that matter).

Step away from average numbers, though, and the extraordinary thing is how often investors lost an awful lot more. If over the period you had bought and held IPO stocks, you would have "lost about half your wealth half of the time" and 75% of your wealth a quarter of the time. That makes the average returns on IPOs even worse than the "most bankruptcy-prone categories of leveraged equities", Verdad says. Ouch. Run these numbers back to the 1970s and you find something very similar.

I hope no one is going to be stupid enough to ignore decades of diversification advice and go only for either IPOs or dinosaurs. But this little analysis does operate as a nice reminder of two things.

Advertisement - Article continues below

First, that unless you hit on exactly the right IPOs (or, indeed, the right "growth" stocks), looking to the slightly tarnished over the very shiny isn't a bad idea. And second, that all very long-term studies of investing returns show that long-term portfolio success is generally about paying the right price upfront. Cheap stocks (as measured by lower price-to-book ratios) do outperform expensive stocks. IPOs tend to be overpriced and the debt-ridden and declining tend to be underpriced hence Verdad's results.

Growth stocks have been outperforming for so long now, due to falling interest rates and loose monetary policy, that this stockmarket dynamic has been almost forgotten and has never been seen by younger City workers. The recent IPO reality checks may be telling us that a style shift is nearly upon us. If it is, where should you be looking?

Plenty of value in the UK and further afield, too

A few decades ago I might have answered that question with sector-specific answers. It seemed clear back then that with the march of globalisation there was little point at looking at national markets in isolation. With political risk firmly back on everyone's radar, however, the differences in individual markets are also back in play.

You won't be surprised to hear me say that the UK offers pretty good value at the moment. You'll hear a lot of international investors whining about not being able to find lowish risk yield. Yet the FTSE 100 yields 4.3% (around the same as it did post-Lehman in 2008).

I admit that looking to invest in UK at the moment takes some fortitude. With three general elections and two nasty referendums in four and a half years, this is, as William Dinning, chief investment officer of Waverton Investment Management, points out, "the most times the electorate has been asked to vote in such a short period of time in UK history".

The disengagement and disillusionment stemming from that make the election even harder to call than usual, as does the fact that the combined vote share forecast for the major parties is lower than historically normal, having been over 80% in 2017-2018.

Advertisement - Article continues below

That said, the current polls with the Conservatives on 36% and Labour on 23% should offer a little reassurance, as should the FTSE 100's 4.3% yield.

Outside the UK there is value too. If you are seeking a place where the short-term political discount might be even more overdone than in the UK, Pictet Asset Management's chief strategist Luca Paolini suggests you might look at Russia: it's on a price/earnings ratio of six times half that of the MSCI Emerging Markets index and a price to book value of not much more than one.

If you can cope with owning a lot of oil and mining stocks, the JPMorgan Russian Securities Trust (LSE: JRS) (which I own) yields nearly 4%. If you want somewhere with a less of a political discount and more of a verging on the ridiculous emotional discount built in, try Japan. Here the price gap between growth and value stocks is now wider (and the valuations at the lower end lower) than anyone in the market can remember.

That can't last. If you'd like to be exposed to this kind of value but still feel a little wary of Japan, consider the value-orientated AVI Global Trust (LSE: AGT) which has 26% of its assets invested there.

This article was first published in the Financial Times



Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020

How and where to buy gold coins and bars

We have compiled a directory of leading gold brokers where you can buy gold bullion, coins and bars online, over the phone or even in branch. New t…
14 Jan 2020

Don’t panic about Iran – but don’t sell your gold either

Markets have reacted calmly to the tension between the US and Iran. But don’t get too complacent. It’s still a good idea to hold on to some gold as in…
9 Jan 2020

Here’s how gold could rise above $7,000 an ounce

That the gold price could hit $7,000 an ounce is a logical and plausible possibility, says Charlie Morris. Here, he explains how it could get there.
30 Dec 2019

Most Popular


Money Minute Friday 17 January: UK weakness likely to continue

Today's Money Minute previews UK retail sales figures the UK, inflation data from Europe and industrial production from the US.
17 Jan 2020
House prices

UK house prices may be heading for a Boris bounce

The latest survey of estate agents and surveyors from the Royal Institution of Chartered Surveyors is "unambiguously positive" – suggesting house pric…
16 Jan 2020

Currency Corner: how high can the pound go against the euro in 2020?

In the month in which we should finally leave the European Union, Dominic Frisby takes a look at the pound vs the euro and asks just how high sterling…
13 Jan 2020
Share tips

Class acts going cheap: buy into Europe’s best bargains

Value investing appears to be making a comeback, while shares on this side of the Atlantic are more appealing on metrics such as price/earnings ratios…
16 Jan 2020