Don't Let IPO Buzz Cloud Your Judgment

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Initial Public Offerings (IPOs) tend to attract a lot of investor interest, especially when the company is well-known. However, that excitement isn't always matched by investment returns. Before making an investment decision, it's important to research the company and determine if its stock would be a good fit for your investment strategy and portfolio. This due diligence can be particularly important when you're familiar with the company – though familiarity can mean comfort, you should review the company as objectively as possible.

IPO excitement fades fast

The stock price of an IPO tends to rise on the day it begins trading. Historically, the average first-day return has been 18%.* However, investors who bought shares at the end of the first day didn't always fare as well.

IPO stock prices can be extremely volatile, since frequently there is little financial information about the companies and they may not yet be profitable. In many cases, investor excitement drives short-term changes in their stock prices as the initial demand outpaces the supply of shares. However, a study reviewing IPOs from 1980-2015 found that the excitement appears to fade quickly after the first day, as IPO stocks have underperformed compared to similar companies.*

Familiarity isn't enough

Recently, numerous consumer-facing technology companies have had IPOs. These organizations provide familiar services and products, yet their investment performance was similar to the overall IPO performance of the past 10 years. Their stock prices generally rose sharply on the first day of trading, but in almost every case, their stocks had fallen below their closing first-day price within six months.

The price performance of 22 consumer-facing technology companies following their IPOs is illustrated in Figure 1 (below). On average, these stocks experienced a 41% price increase on the first day of trading, reflecting the excitement-driven demand often associated with high-profile IPOs. However, in the three- and six-month periods following the first-day close, these stocks, on average, experienced declines between 9% and 11%.

Company
IPO Date
IPO Price
First-Day Price Change
Price Change 3 Months After First-Day Close
Price Change 6 Months After First-Day Close
LinkedIn (LNKD)
5/18/2011        
$45.00 109.4% -16.1%
-23.6%
Pandora (p)
6/14/2011
$16.00
8.9%
-40.9%
-39.9%
Zillow (Z)
7/19/2011
$20.00   
78.9%
-25.6%
-22.2%
Groupon (GRPN)
11/3/2011
$20.00  
30.6%
-6.4%
-61.8%
Zynga (ZNGA)
12/15/2011
$10.00
-5.0%
-37.2%
-41.5%
Yelp (YELP)
3/1/2012
$15.00
63.0%
-36.2%
-10.5%
Splunk (SPLK)
4/18/2012
$17.00
108.7%
-17.7%
-11.2%
Facebook (FB)
5/17/2012
$38.00
0.6%
-50.2%
-38.4%
Twitter (TWTR)
11/6/2013
$26.00
72.7%
-21.0%
-31.6%
Zulily (ZU)
11/14/2013
$22.00
71.4%
6.0%
-7.7%
King Digital Entertainment (KING)
3/25/2014 $22.50
-15.6%
-11.1%
-30.3%
GrubHub (GRUB)
4/3/2014
$26.00  
30.8%
0.3%
4.7%
GoPro (GPRO)
6/25/2014
$24.00
30.6%
159.4%
111.9%
Alibaba (BABA)
9/18/2014
$68.00
38.1%
16.4%
-9.9%
GoDaddy (GDDY)
3/31/2015
$20.00
30.8%
7.8%
-3.6%
Etsy (ETSY)
4/15/2015
$16.00
87.5%
-43.9%
-63.2%
Shopify (SHOP)
5/20/2015
$17.00
51.1%
13.8%
9.9%
Fitbit (FIT)
6/17/2015
$20.00
48.4%
34.4%
-6.3%
Square (SQ)
11/18/2015
$9.00
45.2%
-23.6%
-28.1%
Match Group (MTCH)
11/18/2015
$12.00
22.8%
-29.2%
-6.3%
Trivago (TRVG)
12/15/2016
$11.00
7.7%
1.3%
56.0%
Snap Inc. (SNAP)
3/1/2017
$17.00
44.0%
-12.8%
N/A
Median Average
41%
-9%
-11%

Source: FactSet Past performance is no guarantee of future results .

Even if you are familiar with a company's products from a consumer standpoint, as an investor you should make sure you research its prospects and valuation before making an investment decision. While it's a positive sign for markets when companies go public, buying their stock may not be the right investment choice for your portfolio

If you're hearing buzz about an upcoming IPO, remember to take a step back and determine whether the company's stock makes sense within your portfolio and overall investment strategy. Your financial advisor can provide insights and recommendations to help you determine what investments choices will help keep you on track toward

*Source: Professor Jay Ritter, "Returns on IPOs during the five years after issuing, for IPOs from 1980-2015"; "Initial Public Offerings: Updated Statistics"; http://bear.warrington.ufl.edu/ritter/.

More resources:

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