Trading techniques... following flotations

Flotations tend to be highly anticipated events. No wonder: those who buy into initial public offerings (IPOs) during the subscription phase tend to do well, at least initially. One study by Jay Ritter of the University of Florida, covering 9,126 newly listed US companies going public between the start of 1980 and end of 2022 showed that they rose on average by 20.5% during their first day of trading. Even though 2022 was generally a poor year for the stockmarket (with tech stocks doing particularly badly) the 38 US IPOs last year still returned an average of 14.2%.

One reason for this is that the way that companies are taken public, with investment banks agreeing to buy any unsubscribed shares, creates a clear incentive for them to keep the price low in order to ensure that the flotation is fully subscribed. Other reasons include the managers of a company wanting to keep their new shareholders happy. However, after that first day, the new listings’ performances tend to be subpar. Ritter’s study of IPOs between 1980 and 2021 found that those who bought them after the first day would have lagged the market by an average of 18.7% over the next three years.

Interestingly, Ritter found this pattern of good first-day performance and subsequent underperformance was strongest with firms lacking an established record of sales before they floated. Between 1980 and 2021, those with sales of less than $1bn rose by an average of 19.7% on the first day, but then lagged the market by 20.4% over the next three years. Those with sales of more than $1bn rose by only 9.3%, but actually beat the market by 0.2% over the next three years. Tech firms also tended to do better than non-tech firms in the long run, although both lagged the market after the first day.