After a period of stagnation in the IPO market, recent months have brought a significant revival in this investment sphere. A landmark moment seems to have been the debut of Trump Media & Technology Group Corp., a company founded by the current US presidential candidate, with a 55 per cent increase in share value on the very first day of trading. A similarly impressive start was recorded by the well-known social networking platform Reddit, whose shares jumped by 48 per cent. These events may signal the beginning of a new era in the IPO market, making one wonder whether investments in IPOs offer a solid basis for profit or are a risky gamble.
Table of contents:
What is an IPO?
IPO, also known as Initial Public Offering (IPO), is the process by which a company offers its shares to the public for the first time and begins to be listed on the stock exchange. It is a watershed moment for many companies transitioning from private to public company status. The process enables the company to raise new capital from listed investors, which can be used to fund further growth, investment, debt repayment or other business objectives. The diverse nature of IPOs makes it advisable to read the prospectus before participating in any of them, from which we can learn in detail, among other things, how the company has fared so far, what the funds from the IPO are to be used for, and the characteristics of the company's business.
Chart: Conotoxia MT5, US500, Weekly
Situation on the IPO market
The market for IPOs is characterized by considerable cyclicality. History has repeatedly proven that an increase in the valuations of stock indices is often followed by a wave of new IPOs. This phenomenon was particularly confirmed in 2021, when we saw historic peaks on the main indices. In contrast, 2023 saw the lowest number of IPOs on the US stock market since 2016. It looks like the current year has a chance to break this unfavourable trend, especially as most of the main indices have set new records.
Source: StockAnalysis
Is it worth investing in IPOs?
Investing in IPOs is often as promising as it is risky. The decision to commit capital to a particular IPO always depends on an individual assessment of the IPO. In addition to the opportunity to participate in the development of often innovative and rapidly growing companies, investors should be aware of the risks associated with such ventures. IPOs involve significant risks due to high price volatility, the lack of a long history as a public company and the possibility of overvaluation of the company at the time of the initial public offering (IPO). These companies often enter the market with ambitious plans, but without a stabilised market position or predictable earnings, this can make it difficult to accurately assess their value. Furthermore, the limited availability of information and the potential difficulty in interpreting available data can increase investment risk.
Analysing the overall trend of IPO day investments, it is noted that the median return on IPO day stocks since 1980 has been 7 per cent. However, 2023, which has been characterised by the lowest number of IPOs in recent years, has also produced some of the worst performance on record.
Source: Conotoxia own analysis, Data survey Jay R. Ritter, Cordell Eminent Scholar, Eugene F., Warrington College of Business, University of Florida
If we look at what percentage of IPOs ended with a positive return, the multi-year average looks very optimistic at 70.6 per cent. Again, in this respect, 2023 was one of the worse years on record.
Source: Conotoxia own analysis, Data survey Jay R. Ritter, Cordell Eminent Scholar, Eugene F., Warrington College of Business, University of Florida
But has it historically paid to hold on to shares for more than one day after listing? It turns out that, on average, companies achieved a positive return during the first year of listing, which was 6 per cent. Unfortunately, this is not higher than the average annual return of the main S&P 500 index, which was 10 per cent during the period analysed. Furthermore, it is worth noting that during periods of economic downturn, IPOs often underperformed the market.
Source: Conotoxia own analysis, Data survey Jay R. Ritter, Cordell Eminent Scholar, Eugene F., Warrington College of Business, University of Florida
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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