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
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
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
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

Advertisement

Recommended

Visit/517688/the-british-equity-market-is-shrinking
Stock markets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019
Visit/511212/reasons-for-investors-to-be-bearish-but-stick-with-the-stockmarket-bulls
Stock markets

There are lots of reasons to be bearish – but you should stick with the bulls

There are plenty of reasons to be gloomy about the stockmarkets. But the trend remains up, says Dominic Frisby. And you don’t want to bet against the …
17 Jul 2019
Visit/510684/good-news-on-jobs-scares-stockmarkets
Economy

Good news on jobs scares US stockmarkets

June brought the best monthly US jobs growth of the year, but stockmarkets were not best pleased.
11 Jul 2019
Visit/510135/trade-war-ceasefire-boosts-stockmarkets
Economy

Trade-war ceasefire boosts stockmarkets

Stockmarkets sighed with relief after the G20 summit in Japan brought a handshake between Donald Trump and Xi Jinping.
4 Jul 2019

Most Popular

Visit/investments/property/house-prices/600840/the-biggest-risk-facing-the-uk-housing-market-right-now
House prices

The biggest risk facing the UK housing market right now

For house prices to stagnate or even fall would be healthy for the property market, says John Stepek. But there is a distinct danger that isn't going …
17 Feb 2020
Visit/currencies/600842/eur-usd-euro-slide-against-us-dollar
Currencies

The euro’s slide against the US dollar looks set to continue

The euro has been in a bear market against the US dollar for two years now. And on a broader scale since 2008. A decline like that is telling us somet…
19 Feb 2020
Visit/investments/stocks-and-shares/share-tips/600811/three-overlooked-stocks-to-buy-now
Share tips

Three overlooked stocks to buy now

Each week, a professional investor tells us where he’d put his money. This week: Joe Bauernfreund, portfolio manager at the AVI Global Trust, highligh…
17 Feb 2020
Visit/investments/commodities/600729/the-rare-earth-metal-that-wont-be-a-secret-for-long
Sponsored

The rare earth metal that won't be a secret for long

SPONSORED CONTENT – You can’t keep a good thing hidden forever; now is the time to consider Pensana Rare Earths and the rare earth metals NdPr.
31 Jan 2020