I found one of the best definitions of IPOs in this SmartMoney column: the author says that IPO stands for “Its Probably Overpriced” rather than “Initial Public Offering”. The trouble with IPOs is that they are lousy investments. I am now reading Contrarian Investment Strategies by David Dremen and he talks about a study (by Prof. J. Ritter and Tim Loughran) of IPO returns:

The study followed the returns of 4,773 IPOs traded on the New York Stock Exchange, the AMEX and Nasdaq between 1970 and 1990. The average return for IPOs was 3% annually compared to 11.3% for the S&P 500.

But, there is more bad news:

The median return for these almost 5,000 initial offerings was down 39%. That’s right. If you couldn’t get that handful of red-hot IPOs that doubled or even tripled on the first trade – and nobody but the largest money managers, mutual funds, or other major investors could – then you’d lose a good chunk of your original investment.

Tim Hortons (TSX: THI), which went IPO with much fanfare just a few months back, is now trading at $29 after changing hands between $33 and $36 on its opening day of trading. The VoIP provider Vonage (NYSE: VG) went public last week at an offer price of $17. The stock has been in a free fall ever since and closed trading today at $12. Vonage, which operates in a brutally competitive market also managed to alienate its customers by offering them shares before the IPO only to watch it plummet after its debut. Overpriced is a fair description of these investments.

This article has 4 comments

  1. I read the same book and have the same conclusion. I do not understand why you want want to be among the first own a stock. I guess there have been a few spectacular success and that is what everyone remembers. The much much more common disappointments are forgotten.

  2. Great post!

    I think the reason people feel a need to get on the IPO is because the Street likes to sell “the next Microsoft” where if you could only have gotten in “on the ground floor” you would be set.

    Truth is, the ground floor investors are the people who invested BEFORE the IPO. IPOs are not priced to be cheap, they are priced to maximize investment banking fees.

  3. I think the recurring theme still applies in this post. Don’t buy the IPO, buy the investment banker. Unfortunately, in Canada our choices are limited as the biggest investment bankers are buried in the Big 5 banks. The only sizeable publicly listed “pure-plays” in investment banking are Canaccord Capital and GMP.

    The IPOs which are properly priced and of good size (and thereby offer some value at the time of the IPO) have all been picked over by the large institutions, fund managers and wealthy individual investors before. By the time that we the retail investor, get a chance to buy it – it’s nothing more than table scraps or dog food. The only IPOs that we can buy are the worthless ones.

  4. Benjamin Graham wrote in 1973 in the Intelligent Investor that all investors (not speculators) should basically stay clear away from these stocks, which he calls “hot new issues”. Too bad for many that they didn’t read his work.