Hot IPOs don't equal huge gains
IPOs that soar on their first days of trading often post the least impressive results over the next six to twelve months, according to a new study.
The study found that the hottest IPOs--ones that rise over 50 percent on their first days of trading--fall 4.2 percent on average during the next 180 days, with a median decline of 15.4 percent. IPOs that rise up to 50 percent average a 10.5 percent gain during the next 180 days, with a median rise of 4.8 percent. Those offerings that dipped on their first days typically rally in the days that follow, posting an average gain of 3.9 percent over 180 days and a median of loss of 5.4 percent.
"When a hot IPO comes out at first and goes up 150 percent to 200 percent in one day, individual investors should not be fooled by the returns," said the report's principal author, Gary James. "Over the long run, the market pretty much corrects itself and drops [the offering] down to its true market value.
"When there's a hot IPO, people get on the bandwagon and buy and buy, especially because of all the publicity a soaring IPO get," James added.
While some Internet companies that were planning IPOs during the past few months have pulled their offerings because of shaky markets, many who did proceed saw their shares rise as much as 200 percent during their first days of trading. The CommScan study indicates, however, that investors should cast a critical eye toward these high flyers during their first year as public companies.
For example, shares of Entrust, a vendor of certificate authority software, rose 25 percent during the company's first day out of the public gate on Tuesday. Today, the stock is down 4 percent at 19.19.
Other soaring IPOs this summer include the record-setting Broadcast.com, which more than doubled its share price on its first day of trading, and GeoCities, which rose 120 percent. Both companies, however, since have fallen to earth. Broadcast.com is down 23 percent from its summer peak, while GeoCities is down nearly 36 percent.
Investors now should look more closely at IPOs that barely moved initially, said Ken Fleming, a research analyst at Renaissance Capital's IPO Fund.
"A lot of stocks that come out during weak IPO markets tend to do better because they are being priced at unbelievably low levels," he said. "Even though they don't get recognized early, the market eventually realizes the value of some of those companies."
James's research methodology was to track companies that went public between January 1, 1994, and August 15, 1997. Each company was studied for a static period of 180 days, and was evaluated again one year from the day they went public so that the varying IPO dates would not skew the study's results.
The report found that, a year after going public, companies that rose over 50 percent on their first days of trading fell 21.4 percent on the average, with a median decline of 34.4. Those that gained up to 50 percent on their first days saw 13.8 percent returns on average, with a median gain of 3.3 percent. IPOs that dipped below their target price on their first days of trading actually rebounded to post average returns of 11 percent, with a median decline of 6.9 percent.
In looking at the long term, the average returns for all companies tracked by the study during the three years after their IPOs show that those with the most dramatic gains initially fell nearly 35 percent, while those that gained nothing on their first days now are up 4.6 percent. IPOs that rose up to 50 percent currently are down 5 percent.