The IPO Survival Guide - Why the Issue Price plays a key role in IPO profits

This is the second article in a series of blogs that we are publishing on the back of Stockopedia research into the performance of IPOs (initial public offerings). The IPO Survival Guide examined 258 IPOs between 2016 and 2021 - and one of the most interesting findings involves the all-important ‘issue price’.

The issue price is the level at which an IPOing company and its advisers ‘price’ the shares before they begin trading publicly for the first time.

Based on our sample of IPOs, buying at the issue price virtually guarantees you a profit on the first day of trading. In fact, the first-day ‘price pop’ led to a profit, on average, 90% of the time.

The problem, of course, is that because of the way IPOs are usually structured, most private investors don’t get the opportunity to buy at the issue price. This puts them at a big disadvantage.

The Issue Price - where the City profits, and private investors aren’t allowed in

To understand why the issue price is so important - yet so inaccessible to private investors - it’s worth looking at some basic IPO mechanics.

IPOs are a popular way for companies to raise the capital they need to fund their growth ambitions. They also enable existing owners and directors to sell some or all of their holdings in a company.

To make this process as efficient and low-risk as possible, investment banks and brokers like to secure large orders for chunks of shares upfront from their major clients. Normally, these are institutional investors.

It’s reasonable to think that the company and its advisers will seek to achieve the highest price possible. But the sceptical onlooker might deduce that in exchange for pledging to buy big portions of shares, the institutions are offered an issue price that bakes in room for an early profit.

First day profits are never guaranteed, and some IPOs do fall at the open, but Stockopedia research shows that price pops are the norm. This means that the unwary private investor - whose first chance to buy shares in a new IPO is usually on the first day of trading - is already at a major disadvantage.

This is a great shame because our analysis found that of the 237 IPOs that experienced a price movement from the issue price compared to the opening price, 211 were positive (the equivalent of an 89% hit rate).

Furthermore, the average price “pop” from the issue price to the opening price on the first day of trading is nearly 10%.

You could, in theory, adopt a randomised strategy of buying IPOs at their issue price, selling immediately at the open and consistently make money.

To add insult to injury, in those cases where private investors are invited to buy shares at the issue price, the outcome is still uncertain. There is some evidence that these IPOs don’t ‘pop’ on the first day - and the IPO of Deliveroo in the UK was a prime example, as was the IPO of trading app Robinhood in the US.

You can read our introductory blog on The IPO Survival Guide here. In future articles we’ll be looking at the how company size, sector and exposure to factors like Quality and Value can all have an influence on the chances of profiting from new IPOs.

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The insights in this article are taken from our IPO Survival Guide. In it, the team at Stockopedia provides unique insights into the world of IPOs, derived from data on over 250 UK IPOs between 2016 and 2021. These insights will allow you to make better and more informed investment decisions when presented with the next 'hot' IPO. You can download the full guide for free here.