Why Tech IPOs are a Losing Bet for Investors

Why Tech IPOs are a Losing Bet for Investors

The year of the tech unicorn—Zoom, Uber, Lyft, and others—is shaping up to be the busiest year for tech IPOs in nearly twenty years. But investors hoping to snap up early-minted shares in order to profit from mega returns are likely to find many of these stocks are a losing bet. A new study conducted by Aneet Chachra, a portfolio manager of a hedge fund managed by Janus Henderson Group, shows that tech stocks purchased the first day they become available to the public dramatically underperform the market -- by an average of 10% -- during the first year, according to a detailed story in Barron’s as outlined below. 

Why Tech IPOs Are a Losing Bet

· Median underperformance: 19% in first year

· Average underperformance: 10% in first year

· Reason 1: tech IPOs tend to be initially overvalued

· Reason 2: downward price pressure following 6-month lockup period

Source: Barron's, per Janus Henderson's study of 220 IPOs

What it Means for Investors

Examining every U.S.-listed tech IPO over 12 months during the eight-year period between the January 2010 and March 2018, Chachra compiled data on 220 tech companies. He found that if you can get in at the initial IPO’s deal or offering price, before it starts trading in the secondary market, then “you are going to do well.” Otherwise, being one of the early buyers at the stock’s opening price in the secondary market is likely to end in underperformance for the first year.

For investors who were able to purchase a tech stock at the initial offering price, average first-day gains were 21%, Chachra found. But for investors who bought in at the opening price on the first day of trading in the secondary market, the median underperformance in the first year is 19% and the average underperformance is 10%.

Chachra attributes two reasons for the poor short-term performance of tech IPOs: behavioral bias and the lockup period. Behavioral bias points to the tendency for tech IPOs to be initially overvalued when they first start selling in the market, a feature that tends to be exacerbated by the preference most companies have for only going public when market conditions are strong. The lockup period refers to the regulatory six-month period that early venture capital investors must wait out before selling their shares. Following that period, there is often downward price pressure as these investors sell their shares.

Looking Ahead

Giving these findings, investors may want to wait at least a year before pouncing on the next big tech IPO such as Uber’s. By waiting, “You may get another opportunity to buy at a much more attractive level,” Chachra says. Facebook is a case in point. It fared poorly soon after its 2012 IPO, but has risen nearly five-fold over the past 7 years. Studies looking at the longterm performance of IPOs, though, suggest caution is warranted even in these cases. A recent UBS study shows that more than 60% of at least 7,000 IPOs from 1975 to 2011 had negative absolute returns after five years in the secondary market, per a story in CNBC. While an IPO is usually an indication that a company is growing quickly and wants to expand even more, that still may not guarantee that it's a winner as an investment.

Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.