Easy money being made in IPOs? That’s not always been the case

2020 was a year when easy money was made in the stock market. Everybody who invested in the market at any point in time of the year was better off at the end. People who were especially better off were the ones who invested in IPOs that opened last year. All they had to do was subscribe to the IPO, pray for an allocation, and eventually sell the allocated lot in the secondary market on listing day. How much did they make? An investor who put in Rs.10,000 on each of the IPOs listed in 2020, made a total trading profit of Rs.53,422 – A total return of an astonishing 434% in one year. 11 of the 15 IPOs from 2020 listed with positive gains and all the 15 are trading above their IPO prices as of last week. So, is that it then? Have we figured out where the money tree grows? Inside the IPO forest? Well, not so fast.

IPOs - A look back

Here is a look at listing day gains made by IPOs over the last 15 years.

2020 was a fantastic vintage. 36% average listing day gains were recorded across the 15 IPOs. But we have had rough years in the past. To be honest, we have never seen gains similar to 2020 in the past. Take a look at the chart below which plots average listing day gains over the last 15 years. Average listing day gains in 2011 was 0.78%. 2012? 4.23%! 2013? 5.68%! 2020, was by far, the best year for IPOs – the outlier.

2020 was exceptional not just from an overall average perspective. Consider this – 11 out of 15 IPOs that listed last year made money. Compare that with the year like 2007 when close to 30 of the 90 that listed did not make positive gains on listing day.

But even this hides a trend. Notice how a lot of the gains came from just 2 stocks? These are the IPOs of Burger King and Happiest Minds. These two put together contributed to almost half of the total average of 36%. If an investor had missed out on these IPOs, his gains would have been substantially lower. And given the massive oversubscription that these issues witnessed, there is a good chance most investors did not get any allocation at all from them. The chart below shows the contribution of the biggest IPO ‘pop’ to the averages over the years. In 2011, 380% of the average gains came from the top IPO pop of the year – which meant that most of the rest made losses!

Here is a frequency distribution of listing day gains made by companies that listed through IPOs since 2006. The kind of returns that investors’ witnessed this year from The Happy Minds or Burger King are so far out to the right in the graph. The median listing day gains historically is in the region of -20% to 0%!

IPOs - The Long Term Story

Listing day gains aside, data suggests that IPOs are terrible investments over the long term. This chart shows individual till-date CAGR returns from investing in each of the IPOs listed in the market over the last 15 years. Just 168 of the 436 IPOs listed in the last 15 years have made any money at all to date.

Why then are IPOs so popular?

Cognitive biases explain why this is. It is human nature to generalise things quickly & hastily. And our tendency to hastily generalise is based on yet another bias called recency bias. Imagine a caveman going to a particular location in the forest to procure food in the morning and he sees some dangerous predators there, but they aren’t there when he goes there in the evening. After observing this a few times, he has concluded that it’s safe to go there at dusk.

That is exactly what we have done with IPOs. We have hastily generalised that they are excellent investment opportunities based on what we have observed last year. But data alludes that IPOs have been terrible long-term investments. Even listing day gains have been less pompous in the past than what we have seen recently. However, the stories we read in the media about that latest IPO ‘pop’ deceives us into creating a narrative that is dangerous. It is our hard-earned money, and it is our responsibility to make sure we properly evaluate the risks before investing. A good investor should only put money on the table if it is a good business and will create long-term value for stakeholders and wealth for investors. Not every business that comes out with an IPO does that.

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