Everything around IPOs is setup to work against an investor. Traders may profit from the initial spike, but the odds are stacked against someone who plans to invest for 2-3 years
The Math is not in your favor
Let’s analyze the numbers from a long term perspective. Around 935 companies were listed in the last 3 years and 330 of these companies beat the index over this period. In other words, you had better odds of earning higher returns in the nifty index versus a randomly selected IPO
It is worse if you dig deeper into the data – Close to 50% of all IPO in the last 3 years are below their IPO price, so investors on average broke even over a 3 year period.
It gets even worse if you analyze the data in the short term when a lot of people are buying into the hype. The return for an IPO , 60 days post listing, is negative on average due to the ‘buyer’s trap’. This occurs as most of the alpha has already been extracted by the primary allotees who were given the stock before the IPO at a lower price
Why do investors loose money ?
The reason is not difficult to understand. I wrote a post long time back (in 2007 !!) on this topic and nothing has changed since then
The key reason is that an IPO is an event where motivated sellers try their best to sell overpriced merchandise to buyers
Before we get worked up about the innocent, unsuspecting buyer, let me point out that buyers are equally to blame. The buyer is not being forced to buy anything. No one is holding a gun to your head to buy an IPO
I am neither a buyer nor a seller in IPOs and have no axe to grind. I have never bought an IPO for myself, my family or my clients in the last 25 years
The seller (existing owners/promoters) try to price their company as high as they can. What do you expect them to do ? will you do something different ? When we are sellers, we want the best price for our stuff too
I am not condoning the bad behavior of sellers and their enablers (the merchant bankers) who dress up a company to make it appear better than the reality. That said, the truth is that a company is always presented in best possible light and then priced to the extreme at the time of the IPO – The groom and bride get in their best shape before their marriage 😊
To ensure that the IPO is a success, merchant bankers pull no stops. There are roadshows (marketing events), TV interviews, influencer pitches and so on. This is similar to promoting a new movie where all marketing tools are used to generate excitement around the company
The odds are stacked against you
Lets put the various points together
- The company financials have been dressed up before the IPO to show it in best possible light
- The IPO is priced to the highest level the market can bear
- IPOs are launched during during strong markets when investor enthusiasm is high
- There is considerable marketing push generated around event to create excitement and demand for the IPO
- Pre-allotment of company stock to preferred investors, insiders and employees at below IPO price
- Expiration of lockin after the IPO event resulting in excess supply into the market
The solution to all of this is very simple – Don’t play the game where the odds are stacked against you. If you want to look at such companies, analyse them like any other stock. Look at the company, its performance and valuations after all the hoopla has died down
In my own case, I have bought companies which have listed long after the drama had died down and the valuations were reasonable. It was no different from buying any other company listed on the market
