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Understanding The Outcomes For Recent IPO Stocks

|Includes: Facebook (FB), GRPN, P, ZNGA

The saying goes that you can't fool all of the people all of the time. True enough. But you can fool enough of the people enough of the time to get them to play in the IPO markets. I don't want to beat a dead horse here, as FB drops below $20 and the lockup is ending, effectively doubling the float of Facebook. That said, I am amazed that so many people with money to invest simply don't take the time to investigate the history. Wall Street does a great job of pitching shares, but there is a lot of research in this area going back a long time.

I reviewed some of the literature on this problem in June 2011 in this article, which notes (among other things):

When standard factors known to impact performance are taken into account (small cap vs. large cap, value vs. growth), IPO stocks show a tendency to substantially under-perform over a three-five year period after going public. Dr. Jay Ritter at the University of Florida regularly updates his research on this effect. In his most recent results (published in June 2011), the average three-year return of IPO stocks lagged the average three-year returns of similar non-IPO stocks by 7.2%.

So perhaps we should conclude that most of the public investors are trying to time the markets in IPO stocks for a short-term gain. How does that work?

In a related piece in May 2012, I discussed the literature from behavioral finance that looks at investors' tendencies in relation to IPO stocks relative to their propensities to gamble. There is plenty of research to suggest that IPO investors are quite likely to be the same people who believe that, against all odds, they will make money playing the lottery or going to Vegas.

The powerful lesson here is that an investing pitch that resonates with peoples' desire to get something for nothing or to turn a tiny investment into riches will consistently attract people and their money, all evidence to the contrary.