Alibaba (BABA) goes public Friday in what will likely be the largest U.S.-listed IPO ever. The media hype is undeniable. Should you give in?
We looked at a few of the most hyped-up IPOs of the past four years and found that investors buying on the first day of trading pay, on average, more than the IPO’s offering price at market open. And that “premium” eats into potential gains.
Since its 2011 IPO, for example, LinkedIn (LNKD) shares are up more than 360% (as of September 16, 2014) — yet IPO investors who track their accounts with SigFig have an average 67% unrealized gains.
Here’s what investors should know about IPOs before they jump on the next big one:
The first-day premium
The average first-day pop – or price spike – for an IPO this year is 14%. Last year it was 17%. Historically, it has been 10%.
These one-day returns sound amazing. But as our data shows, everyday investors typically don’t enjoy them. Why? Institutional traders get in earlier, at preferred pricing. IPO shares get pre-allocated to institutions. Everyday investors have to wait till the opening bell. When the shares are available to the public, the price reflects the actions of the institutional investors.
There are, of course, exceptions. Facebook (FB) investors only paid a 5% premium to purchase price as the underwriters boosted the initial share price three days before the IPO and Facebook released 25% more shares to meet the huge demand. A premium was baked into the price before the opening bell. The market was flooded with overvalued shares. When the stock didn’t get a pop and some negative reports on FB came out, the stock took a long slide. Of course, if you stuck it out you’d be pretty glad now.
And there are the outright flops. Zynga (ZNGA) investors paid an average $10.06 to go in on the company’s December 16, 2011 IPO, barely above the initial offering price of $10. Today, the stock trades right around $3.
A turbulent ride
The months following IPOs are notoriously shaky as big institutional investors flip shares, and employees and early investors sell out after the end of the customary six-month “lock-up” period.
Last May, as Twitter’s lockup period expired, insiders dumped shares causing a 17.8% one-day drop to $31.85: well below the average investor’s purchase price of $44.50 on IPO day.
Selling early — or holding on for too long?
Parsing through SigFig data, we found that many investors sell their IPO stocks within months of buying. Some 73% of GoPro investors (the company IPO’d less than 3 months ago and is up 180% since then) have already sold at least some of their GPRO shares.
Yet 61% of MediWound (MDWD) IPO investors seem to be hanging onto their stock, despite its 41% drop since its IPO in March 2014.
Warren Buffett himself has said that IPOs are almost always bad investments because of the hype involved. Research suggests that in the long run IPO companies underperform comparable companies.
If you do want to play the IPO game, keep in mind that just like investing in any individual stock, you’re taking a risk on a single company.
As usual, one caveat about our data: it represents the activity of investors who track their portfolios on SigFig. They may not be representative on investors as a whole.