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Background and Research
Initial Public Offerings (IPOs) can generate a great deal of interest and media attention especially when they experience large increases in value during initial trading. Internet related offerings in particular have received a great deal of publicity in the last year. There are now a number of free services available on the web that provide information about IPOs. However, the challenge for most investors continues to be getting the opportunity to buy shares of IPOs on the offering. In addition, investors should also beware that a great deal of evidence shows that in the past, IPOs in aggregate have underperformed the market.
Research showing that IPOs are poor long term investments has existed for quite a while. See Nightmare in Fantasyland by David Dreman in Forbes (6/2/97). A study by
Tim Loughran and
Jay R. Ritter discussed some of that research and presents additional findings on both IPOs and secondary offerings. The article appeared in the March 1995 issue of the Journal of Finance. The abstract of "The New Issues Puzzle" can be read here. The authors studied IPOs and seasoned equity offerings (SEO) from 1970 to 1990 and found that both underperformed. REITS and ADRs were not included in the study. The authors concluded that "Our evidence is consistent with a market in which companies announce stock issues when their stock is grossly overvalued, the market does not revalue the stock appropriately, and the stock is still substantially overvalued when the issue occurs." See also
Investors Beware by
Roni Michaely and
Kent L. Womack, and Analysts.
Another recent study shows that analysts overestimate IPO earnings. See "Sell-side analysts overprice stocks" by Marlene Givant Star in Pensions and Investments 10/14/96 and "Wall Street Analysts Too Upbeat on IPO Earnings, Study Finds" from Reuters in The Los Angeles Times 10/23/96. The articles referred to research by
Richard Sloan, Patricia Dechow, and Amy Sweeney. They found that long-run earnings forecasts by sell-side equity analysts were systematically overly optimistic, particularly those employed by the lead underwriter. Despite Chinese Walls between their underwriting and research departments intended to prevent conflicts of interests, the researchers said: "the study's results are consistent with investment banks using their sell-side analysts to help promote their underwriting clients." See also IPOs.
Several recent articles including Paradigm Surfing and "Coattails" (near the end of the page) in Forbes 11/4/96 (See the accompanying Chart of Venture vs. non-venture-backed IPO's) and Inter@ctive Week's "Venture Capitalists Offer Leg Up For Small Investors" 12/9/96, have reported that research shows that IPOs by companies backed by Venture Capital firms have significantly outperformed IPOs not backed by venture capital firms.
(See also Venture Capital.)
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