This article first appeared in the March 2012 newsletter. Subscribe to get articles like this in your inbox.
With Yelp, LinkedIn, Zynga, and Groupon completing IPOs in the past year and Facebook on the way, interest in IPOs seems to be surging. As with any investment strategy, my first reaction is to look for data. And not just data on a handful of recent IPOs for scenario analysis, but data on all IPOs over decades of market history.
The effect most investors are familiar with is that shares tend to appreciate significantly on the first day of trading. This is fully supported by evidence.
| Years | Number of IPOs |
Avg First Day Return |
| 1980-1989 | 2,054 | 7.2% |
| 1990-1998 | 3,610 | 14.8% |
| 1999-2000 | 857 | 64.5% |
| 2001-2011 | 1,096 | 11.7% |
| Total | 7,617 | 17.9% |
From 1980 to 2011, the average gain on the first day of trading is about 18%. Even if you remove the bubble years of 1999-2000, IPOs still average a return of 12% on the first day. This return obviously varies by company, but buying IPOs at the offering price seems to be a very profitable strategy.
Typical Investors
Unfortunately, buying an IPO at the offering price is really difficult if not impossible, since most shares are sold to large clients of the underwriters. For most investors, your first chance of buying an IPO is on the first day of trading–after the shares have already appreciated.
So how about buying shares after the IPO?
| Sales | Number of IPOs | Avg 3yr Return |
Avg 3yr Return, Market-Adjusted |
| 0-49.999 mm | 3,939 | 5.2% | -35.3% |
| 50 mm and up | 3,474 | 39.2% | -2.0% |
| Total | 7,413 | 21.1% | -19.7% |
From 1980 to 2010, the 3-year performance of IPOs bought on the first day has lagged the broad market by an average of 20%. Although this under-performance disappears for companies with significant revenues (more than $50mm in 2005 dollars), buying IPOs on the first day does not look like a profitable strategy.
Employees
As an employee of a company completing an IPO, you are in the opposite situation of already holding shares and looking to reduce your position for risk management purposes.
Considering the performance record above, selling all unrestricted shares as soon as possible seems to be a decent default strategy, especially for employers with low revenues. However, making large, abrupt portfolio changes incurs significant risk. It can be particularly painful to see shares appreciate rapidly after selling a large block.
A common solution is to sell incrementally over a period of time to reduce this risk–usually over a few months to a few years. The length of time can be adjusted based on personal factors: your tax situation, the amount in employer stock relative to your overall portfolio, your desire for full diversification, your employer's growth prospects, your influence over company performance, etc.