IPOs seem exciting. When a familiar company announces they are going public (known as an Initial Public Offering), questions sometimes come up. A client may ask, “can I make lots of money buying this new opportunity?”
Recent stories tout riches made on the IPOs of Lyft and the media darling Beyond Meat. I admit I’m curious about their meatless burger – anybody try it yet? So, is investing in IPOs a good idea for your average investor?
Investing in IPOs – Yay or Nay?
My friends at Dimensional Funds wrote a great analysis in their blog post “IPOs: Profiles Are High. What About Returns?” (Disclosure: I use Dimensional mutual funds for many of my clients.) It’s a well-researched piece and I encourage you to read it if you’re interested.
If you’re less interested in the data and analysis, here are the three takeaways:
- You aren’t getting the best shares. The underwriting bank decides who gets IPO shares. They usually first offer shares to their biggest clients. If any shares are not used, you probably don’t want them. They were either turned down or the bank doesn’t have confidence of a short-term increase.
- Longer-term performance is spotty. If you can’t get quick returns on day 1, what about buying as soon as you can and holding for a while? DFA determined that a portfolio of IPO stocks provided lower returns and more risk than simply buying an index fund. You might get lucky and find the next Amazon, but you may also be buying Pets.com. (remember them?)
- IPO stocks have traits that lead to lower performance. I’ll quote DFA here: “IPOs have underperformed the market because, as a group, they have behaved like small growth, low profitability, high investment stocks, which have had lower expected returns than the market.”
The Moral of the IPO Story
Every investor would love to strike it rich by buying the next Google or Amazon early on. If I thought IPOs could deliver better returns to my clients (and myself), you bet I would add them to our portfolios. But the sober mind realizes that the excitement and success portrayed by the media is only enjoyed by the privileged and the lucky. And if you won’t take my word for it, Warren Buffett recently agreed with me!