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Lesson in Course: Medes Newsletter (advanced, 8min )
Should I consider buying an IPO on opening day?
In a previous post, we looked at how some highly anticipated IPOs have fared so far in 2019. As an average investor, buying shares on the first day of trading would have resulted in gains for half of the investments made. Today, we’re going to take a look at a larger data set and see if we can conclude whether buying on the first day is, in practice, a good idea or not.
The timing around when to participate in an IPO is a fairly controversial topic among seasoned investors with many preferring to wait. During the initial periods of trading, a stock can often behave similar to a hot collectible with prices bid up artificially high due to a large amount of demand rather than behaving like an ownership stake in a business.
“I think buying new offerings during hot periods in the market … I don’t think it’s anything the average person should think about at all”
-Warren Buffet on the eve of LYFT IPO
What Warren Buffet is referring to is the pop in the share price during the first period of trading as investors rush in and the number of buyers outnumbers the sellers. We can see an example of this during BYND’s first day of trading.
Open price: $46.00
Highest mid-day price: $72.95
Closing price: $65.75.
The intraday range, or the swing in prices during a single trading day, is huge for BYND with prices almost nearly doubling from the starting price of $46 up to the high of $72.95, an increase of 59% from the start of the day! As a retail investor, someone who isn’t getting paid to invest for other people, placing a market buy order during a time other buyers are piling in can result in a purchase price being closer to the intraday high rather than the current quoted price.
Professional money managers, or institutional investors, pay large sums for trading data that tells them:
With this information, institutional investors get a much more accurate prediction on the per-share price their trades will execute.
Note: there are different types of purchase orders outside of market orders that can be used. Some savvy investors buy into IPOs with a limit order. We cover these alternative trade execution strategies in another post.
To help answer our question of when to participate in an IPO, we are going to take a look at 21 relatively well-known companies covered by the press on the day they went public. 6 of these 21 companies should look familiar from the previous post.
Pinterest (PINS), Lyft (LYFT), Uber, (UBER), Zoom (ZM), Beyond Meat (BYND), Slack (WORK), PagerDuty (PD), GoPro (GPRO), Tesla (TSLA), Facebook (FB), Stitch Fix (SFIX), Blue Apron (APRN), Snapchat (SNAP), Spotify (SPOT), Dropbox (DBX), Docusign (DOCU), Shake Shack (SHAK), Twilio (TWLO), The RealReal (REAL), Chewy (CHWY), and Fiverr (FVRR).
Let’s assume that we are going to participate on the first day of trading no matter what. Since we can’t reliably guarantee the price at which we would be buying the shares, we’ll go on and assume the worst-case scenario — buying at the highest point in the day.
Let’s take a look to see if we would have made or lost money.
From the sample of 21 companies, we see some fairly outsized performers like TESLA, TWLO, FB, and BYND all well over 200% gains. 11 out of the 21 companies resulted in losses with some substantial losses such as GPRO, APRN, REAL, and LYFT at -88%, -96%, -54%, and -44% respectively.
When it comes to investing, the chance of losing money, or downside risk, is a major concern among investors. The math around downside risk will show us why.
For example, suppose we start a position at $100. If on the first day we see a loss of 50%, but then the following day saw a gain of 50%, at a glance we might assume we would have broken even. However, this isn’t how the math shakes out.
Now let’s assume on the first day there is a gain of 50% then followed by a loss of 50% the next day. We’ll see that this doesn’t result in a better outcome. We’re again at a total loss of 25%.
In the case of GPRO(-88%) and APRN(-96%), we would need some astronomical gains just to breakeven. Due to just how deep the downside price movements can cut here, it’s often prudent to not rush in.
Now that we have a pretty good idea of what would have happened had we purchased at the highs of the first day, let’s take a look at what would have happened had we waited. We’ve chosen to look at the start of the next day, waiting for 1 month and waiting for 2 months to see if we can spot any trends.
We’ve simplified the analysis by transforming our percent gains or losses to the value we would have today if we bought $100 into each IPO. Below represents a table of values for each stock at the different time points purchased and is formatted with a gradient with lighter colors representing higher dollar values.
There’s no consistent pattern that can be observed across the different time points for the 21 companies. For LYFT, FB, SPRN, SNAP, DBX, WORK, and APRN, waiting a month or two had the best outcomes — for the majority, it would have resulted in losing less money.
To help us answer our question around timing, we are going to assume that we have no bias and participated equally with $100 in all 21 of these IPOs. We’re going to add our values across all 21 companies for each time point to see if in aggregate we notice a difference between waiting or not.
Starting investment: $2,100.00
Today’s value if we bought at high of the first day: $3,343.63
Today’s value if we bought at next day start: $3,569.86
Today’s value if we bought 1 month later: $3,027.20
Today’s value if we bought 2 months later: $2,923.33
Interestingly, with this set of 21 companies, the data suggests that, in aggregate, if we had just waited until the next day we’d fare best¹. While the difference is quite small between the first two days, waiting a month or two had worse results.
While this seems like it flies in the face of Buffet, it is important to note that his experience encompasses many decades of investing, including the dot com boom and other recessions. We are currently in a historic 10-year bull market and the data we’ve looked at might be all skewed upwards. For this analysis to be more conclusive, we would have to look at a much larger sample size of IPOs over longer periods.
For the sake of brevity, we didn’t look at any additional time points such as waiting a week, a few weeks, or anything beyond 2 months. The worksheet this analysis is based on can be found here with the trading data up to 2 months after the IPO date populated. You can create a copy of it and test your hypothesis on different date ranges.
Something important to note is that picking which IPO to invest in requires a detailed understanding of the business through disclosures such as S-1s and analysis. We only looked at the price movement for these companies and assumed at the time of the IPO all 21 companies fit the criteria of being a sound investment. In reality, this is often time-intensive, and had we just bought without doing any analysis, we would have lost money 11 times out of the 21. Had we been more diligent in picking winners, we would have come out much more ahead — but this post is solely investigating IPO investment timing.
Warren Buffett’s advice is sound if you haven’t spent the time to look in-depth at the companies before the IPO date. With the downside math covered earlier, making a few mistakes early can set you back as an investor.