Investing in IPOs: a good idea or a risky affair?

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published 17 September 2024

Private investors seem increasingly wary of initial public offerings (IPOs). Obviously, the number of new listings in London has been low for quite some time and it’s hard to know whether this lack of enthusiasm is simply down to the absence of anything interesting coming to market (most companies with a strong story have preferred to list in the US). However, whatever the reason, the record suggests that it’s no bad thing if they are cautious. Studies across multiple countries consistently show that IPOs underperform on average, and frequently underperform quite miserably. The most comprehensive data on this is, as usual, in the US. That’s largely due to the work of Jay Ritter of the University of Florida, who has compiled statistics on IPOs stretching back to 1975, and the conclusions we can draw from his numbers are pretty stark and discouraging.

IPOs: a recipe for underperformance

The medium-term return on the average US IPO has been considerably less than the market. Between 1980 and 2022, IPOs returned an average of 19.6% in the first three years after listing – roughly half the average market return. So as a broad conclusion, you’d have done better buying the market than buying IPOs.

That said, this varies a bit according to the characteristics of the company. IPOs that are unprofitable when listing do much worse; they lost 0.3% over three years, compared to a 34% gain from profitable ones (still worse than the market, but an improvement). The size of the company also matters: those with sales over $100 million (in 2024 dollars) do better on average than those with lower sales. Profitable companies with sales over $100 million do best, with an average return of 40.3%. However, that was still 2.7 percentage points below the market return, so it doesn’t make a strong case for buying IPOs.

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Should you invest in IPOs?

This doesn’t mean that all these newly listed companies are terrible businesses. Some are, but some are simply overpriced and may do well for investors if bought once their shares have fallen back. This is a particular problem for retail investors who typically only get to buy hot IPOs once the stock is trading, rather than at the offer price, because hot IPOs tend to “pop” (go up a lot from the offer price when they start trading). You can see this in tech IPOs in particular: they have an average three-year return gain of 50.2% from the offer price (more than the market) but an average of 21.9% (less than the market) from the closing price on the first day.

And, of course, these numbers are averages that are skewed by a handful of star performers. Almost 60% of IPOs showed a loss over three years. Less than 20% would have doubled investors’ money over five years. In short, IPOs are definitely not a route to quick returns. There will be exceptions, but investors are generally better off waiting for them to become cheaper when the novelty has worn off.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.