IPOs and Superior Returns

IPOs always have fascinated investors. New companies are launched with enthusiasm and hope that they can turn into the next Microsoft or Intel.

Historically,

• The large demand for IPOs means that most IPOs will "pop" in price after they are released into the secondary market, offering investors who bought the stock at the offering price immediate gains.
• For this reason, many investors seek to obtain as many shares in IPOs as possible, so underwriting firms ration the shares to brokerage firms and instituional investors.

A study by Forbes magazine of the long-term returns on IPOs from 1990 to 2000 showed that investing in IPOs at their OFFERING price beat the S&P 500 Index by 4% per year.

However, many investors forget that most IPOs utterly fail to live up to their promise after they are issued. A study by Tim Loughran and Jay Ritter followed every operating company (almost 5000) that went public between 1970 and 1990.

• Those who bought at the market price on the first day of trading and held the stock for 5 years reaped an average annual return of 11%.
• Those who invested in companies of the same size on the same days that the IPOs were purchased gave investors a 14% annual return.
• And these data do not include the IPO price collapse in 2001.