The natural question we’ve been hearing from clients is a simple one: Should I try to get in? As a general rule, we don’t recommend that clients participate in IPOs. That has very little to do with any single company; it has to do with how IPOs actually work.

Let’s Start with the So-Called ‘IPO Pop’

The ‘IPO pop’ is the sharp jump from the offering price to where the stock first trades. The pop is real. The problem is, it’s rarely yours to capture.

To get that first-day price, you need an allocation from the underwriting banks. Those allocations tend to go to the banks’ biggest clients. The deals that are easy to get into are too often the ones with the weakest performance. That means for most investors, the real entry point is the open market, after the pop, at the higher price.

What About the First Year of Trading?

Here the record is sobering. A study by Dimensional of more than 6,000 U.S. IPOs found that, as a group, they underperformed the broad market. And that underperformance wasn’t random. IPOs have tended to behave like small, fast-growing companies with thin profits, and that’s a profile history that links to lower expected returns.

There’s a timing wrinkle, too. Early insiders are usually locked up from selling for six months to a year. When those lockups expire, a wave of new shares can hit the market and weigh on the price, right when many individual investors have settled in.

Take a Look at the Bigger Picture

IPOs do produce winners, but outcomes vary enormously and the excitement around a debut tells you very little about what comes next.

Ready for the part that’s easy to miss? As these companies grow and join the major indexes, diversified investors come to own them anyway. A strong long-term outcome is built on diversification, fundamentals, and patience. Not on getting in early. If you have questions about anything covered in this video, please reach out to your advisor.

 

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