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

IPO Initial Public Offering text — (Image credit: Getty Images)

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

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.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

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 Sholt Heaton is the contributing editor for MoneyWeek.

He 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 experienced in covering 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.