IPOs are not a good deal

This cartoon pretty much explains my attitude towards IPOs. IPOs are almost always bad investments. You are often sold a distant dream at an expensive price. A lot of things has to go right for a new company to succeed. They usually need the money to grow and to take risks and they might need more money down the road. It sounds like with all the new red hot IPOs bursting out of the gate that it’s so easy to get rich. But instead the reality is that most IPOs makes investors poorer. Some IPOs are very interesting companies (e.g. Shake Shack, Fitbit, David’s Tea) and could reward investors in the future but you are paying a lot of money for that risk. Finding the gem is not easy and even if you find it can you get a fair price? IPOs are a good deal for the founders and the insiders who are looking for an exit.

Warren Buffett has a great quote on IPOs:
“It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less knowledgeable buyer (investors).”

IPOs are not cheap

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2 thoughts on “IPOs are not a good deal

  1. I invest in IPO’s from time to time, I believe there are lots of good quality opportunities. Mid sized companies, with profits, looking to expand. Last month I invested in a $300m bank IPO. The company is expanding. A PE of 7, CURRENT EARNINGS, and a dividend yield of 8%. You’re not going to be able to buy a bank on a PE that low unless they are trying to incentivise people to give them money. That is when IPO’s are good investments. That is why so much money is raised on stock markets every year. If every IPO was a bad investment, then IPO’s would not exist. You are looking at the wrong companies. Yes, companies or start-ups with no earnings are most likely a very risky investment. Or if the founders are looking to exit, yes probably a bad investment. You need to look harder or make some better contacts. Earlier in the year I invested into a $500m agriculture deal. It is doing very well. Very profitable. The founders aren’t exiting, they are expanding, rapidly!

    1. Lock, thank you for commenting. Looks like you are doing your homework and you are having success.

      “IPOs are not a good deal” is met in the general sense. It’s not met to be interpreted that all IPOs are bad. Of course not. But in general IPOs are not rewarding shareholders well enough for their risk. If you take 2014-2015 as a sample year, you will get excellent results since everybody is throwing money at anything right now. But if go back to 2000s or even before, studies has demonstrated that the long-run returns of IPO stocks are not particularly attractive, on average. However if you bought a big company IPO, like VISA, GM or Google for example, you would have done well on average. They were already established companies and the IPO didn’t change much to the nature of their operation.The small company IPOs, on the other hand, have been a disappointment for investors,dramatically underperforming the market.
      Like I mentioned in the post if you do your homework and find that gem, then once in a while it’s worth buying a stake. If you see an upcoming IPO that has been pumped up by the media and you jump in with the herd it might not end well for you once the tide turned. They key, IPO or not, is to apply a sound valuation and a margin of safety you will minimize a lot of mistakes.

      Study (last update 2009): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=217108

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