| February 02, 2012
With Facebook’s mammoth IPO inundating the news these days, it’s a good time to remind retail investors they are generally better off avoiding IPOs when they first come out. According to research conducted by University of Florida Professor Jay Ritter, stocks newly listed on U.S. exchanges from 1970 to 2008 trailed stocks of similar market capitalization by an average 4.7% one year after launch, and by 4.0% three years after.
But IPOs are hard to resist. Brokerages want the new issues to do well, so they engage in heavy promotion. And the IPOs for exciting new companies are usually big news items in the media.
Nevertheless, the real investment winners traditionally have been the brokerages’ best customers who are favoured with allocations before the big pop that often occurs on the first day of trading. Ordinary investors don’t usually get a chance to buy until trading begins in the open market (and as a result end up with results like those in Professor Ritter’s findings).
Most serious books on investing advise against buying IPOs.
Burton Malkiel notes in A Random Walk Down Wall Street: “Investors should be very wary of purchasing today’s hot issue. Most initial public offerings underperform the stock market as a whole. ... The managers of the companies themselves … try to time their sales to coincide with a peak in the prosperity of their companies. …”
Benjamin Graham states in The Intelligent Investor: “An elementary requirement for the intelligent investor is an ability to resist the blandishments of salesmen offering new common stock issues during bull markets. ... Some of these issues may prove excellent buys—a few years later when nobody wants them.”
Stephen Jarislowsky writes In The Investment Zoo: “New issues are typically well promoted. ... My experience is that you can buy nine out of 10 new issues at a lower price a year or two later. … I generally avoid new issues. …”
Jeremy Siegel argues in The Future for Investors: “Investing in IPOs is much akin to playing the lottery. There will be a few huge winners, such as Microsoft and Intel, but those who regularly invest in all IPOs will fall significantly behind those who invest in stocks already trading in the public markets.”
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