One of the big problems with investing in IPOs is that investors buy in based on their emotions and their hope that the company will be a huge success for them. Blinded by this, they often ignore the actual price they’re paying.
Statistics back this up, as an average IPO will gain 18 percent on its first day of trading, only to perform worse than other small-company stocks for the next several years. It’s often best to wait for about 30 to 45 days instead of getting in on day one.
The average return on IPOs fluctuates quite a bit from year to year. In 2011, the average total return was negative 9.8 percent. For 2012, it jumped into the plus column at 20.5 percent before increasing to a staggering 40.8 percent in 2013. It fell back down to 21 percent in 2014 and then dropped all the way to negative 2.1 percent in 2015.
The lesson: it’s hard to predict whether an IPO will be successful or not, making it crucial that you do your homework.
IPOs Tend to Be Younger Companies
Since IPOs are often younger companies, the IPO you choose may have a limited track record or an inexperienced management team that is still learning the ropes. It also may not have built up a strong customer base yet. These are all issues for companies at one point or another, but you are taking more of a risk when you invest in a company that hasn’t proven its ability to stay in business for the long haul.
Just because it’s riskier doesn’t mean that investing in an IPO is a bad move. You may make a great trade. For the best chance at success, understand the risks and don’t let hype convince you to pay more for the IPO than you should.