Financial commentators generally agree that this summer’s EU referendum has stemmed the flow of companies floating on the UK stock market. With uncertainty about how the vote will move prices, companies seem reluctant to press ahead with IPOs (initial public offerings).

The good news is that the window for flotations is expected to reopen later this year, with a number of new listings waiting in the wings. But a wider question is whether individual investors should dabble in the market’s newest stocks at all...

A risky investment strategy?

Statistically, history suggests that investing in IPOs delivers a mixed bag of results. Data shows that, on average, the returns from new arrivals aren’t as good as those from companies with an established trading record.

The argument goes that investors and analysts simply don’t have a deep enough knowledge of newly listed companies to value them accurately. Indeed, these firms are likely to have been brought to market at a time when their previous owners are sure of achieving the the highest possible price.

These concerns are reflected in research by Elroy Dimson and Paul Marsh at London Business School. They analysed 3,507 IPOs from 2000 to 2014 and found that the stocks often enjoyed a first day ‘pop’ in price. But after that the average returns were disappointing.

Specifically, the market-value weighted average first day return for investors who bought at the flotation price was 8.5%. Over the next two years, the average loss, adjusted for market movements, was 9.4%. More generally, they found that investment returns are higher depending on the length of time that companies have been listed on the stock market (which is known as seasoning) - as the chart shows.

57472578f3da9Seasoning.png


Analysis in the United States reaches similar conclusions. Jeremy Siegel, a US finance professor who has studied IPO performance, has argued that investors have a predilection for paying too much for ‘new’ whilst overlooking the ‘old’. He’s joined by other academics in claiming that IPOs are systematically overpriced.

Looking to the long term

You could argue that these bearish claims were played out during the floatation of Facebook. As the largest ever tech IPO, all eyes were on the price of the social network when it listed in May 2012. But as its valuation slipped in the weeks afterwards, lawsuits were filed and the company was pilloried. Yet…

Unlock the rest of this article with a 14 day trial

Already have an account?
Login here