Initial Public Offerings (IPOs)

IPOs are highly marketed events. There is an entire intermediary ecosystem that is built to package and sell an initial public offering. These intermediaries have their incentives aligned with the sellers of the IPO. The sellers are either the existing shareholders, or the company itself that is issuing new shares. On the other hand, the buyers in an IPO are all the investors that are generally present in a public equity market, which includes individuals or retail investors. These investors are on their own. The intermediaries (investment bankers and stock brokers) do not have any fiduciary responsibility towards the buyers. Figuratively speaking, in an IPO, the buyers are buying a house through a broker who is getting his commission from the seller of the house. It may feel like the broker is giving free advice to the buyer, through research reports, media presentations or recommendations, but he isn’t really giving advice at all. He is just selling his product.

On the other hand, retail investors tend to invest in IPOs as a trading strategy. They are looking to get a return on their investment in the months or even days after listing. They want an IPO “pop”. Very few retail investors invest in an IPO with a five-year or longer time horizon.

Therefore, there are two good reasons for the long-term value investor to avoid buying IPOs, as a rule of thumb. 

One, IPOs are hyped-up events being orchestrated by people who have no obligation towards the buyer i.e. the retail investor. A good value investor should search for buys in more quiet places. If you really like the company being listed and have a long-term view on it, wait for some time for the buzz to die down and then buy shares, if reasonably priced. 

Two, as a value investor, you must realise that the short-term trader is buying the stock and bidding it up in, and immediately after, the IPO. The way to interact with a short-term trader, as a value investor, is to sell when he is the buyer and buy when he is the seller. In an IPO, he is a buyer. So, even if you can’t sell shares in an IPO, your path should be relatively clear.