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IPOs: Land of opportunity or risky wager?

Initial public offerings can be enticing, but take care and do your research.

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For companies going public, 2016 has gotten off to a very slow start. It is the first time since 2009 that there were zero IPOs in the first month of the year.1 In fact, as of February 4, 2016, just two relatively small IPOs were executed this year—BeiGene (BGNE) and Editas Medicine (EDIT).

This comes after a slow 2015 and is in contrast with the two previous years, which saw the most companies go public since 2007 (see IPO activity graph). The $30 billion in proceeds from 170 IPOs in 2015 marked a six-year low, according to Renaissance Capital.

Last year started off strong, but August and September brought market volatility, and the IPO market wilted. Among the other forces curtailing IPO activity were monetary policy uncertainty, China's economic slowdown, lower energy prices, an uptick in M&A and private market transactions, and underwhelming IPO performance.

Speaking of IPO performance, 58% of IPOs issued last year traded below their issue price for all of 2015 (i.e., these companies never finished a trading session above the IPO price during the year, including the first day of trading), and the average 2015 IPO finished down 4% on a price basis at year-end.2 The average deal size also dropped to $93.8 million, down from $100.9 million in 2014.

In 2015, the top 10 IPOs by size3 were First Data Corp. (FDC), Tallgrass Energy Group (TEGP), Columbia Pipeline Partners (CPPL), Ferrari (RACE), Univar (UNVR), Fitbit (FIT) Blue Buffalo Pet Products (BLUE), TerraForm Global (GLBL), TransUnion (TRU), and EQT GP Holdings (EQGP).

Despite the recent slowdown in activity, a number of highly-anticipated IPOs are expected in 2016. But beware of getting caught up in the hype: IPO investing can be complex, and may be suitable only for experienced investors. Be sure to consider any opportunities within the constraints of your unique investment goals and risk tolerance. Here are some important considerations to keep in mind.

Returns for IPOs can be very volatile.

Last year, the average return for IPOs, from the time of each IPO until the end of 2015, was negative 2.1%, compared with average double-digit gains the preceding three years (see return statistics chart).

Average returns for IPOs can vary widely.

U.S. IPO return statistics
2011 2012 2013 2014 2015
Avg. Total Return -9.8% 20.5% 40.8% 21.0% -2.1%
Avg. First-Day Return 10.5% 14.1% 17.3% 13.5% 14.3%
Avg. Aftermarket Return -17.5% 5.6% 20.3% 7.2% -13.5%
% Trading Below Issue at Year-End 59.2% 38.3% 21.6% 40.7% 51.1%
% Deals with Negative First-Day Return 32.8% 18.8% 26.6% 27.3% 27.1%
% Deals Priced Below the Range 34.4% 39.8% 28.8% 40.0% 32.9%
Source: Renaissance Capital. Includes IPOs with a market cap of at least $50 million, and excludes closed-end funds and SPACs. Data through 12/31/15.

The stock of an IPO can be particularly unpredictable on its first day—and also the first few months—of trading. For every AT&T (T), Google (GOOG), and Visa (V) that had successful IPOs and are now entrenched leaders in their respective industries, there is a long history of initial public offerings that have not performed well.

Moreover, extracting value out of IPOs, even successful ones, can be tricky for a retail investor. For example, suppose you identify an IPO that you find attractive as a long-term investment, and the price at which it begins trading on the IPO date is $20. If you were to buy the shares at around this price, and by the end of the IPO day the stock price had risen to $30, you might think, “I’ve hit the jackpot!”

But take a step back. This means that the company and its underwriters (a financial group, typically a bank that is responsible for determining the market price of an IPO) underestimated demand for the company’s stock. Therefore, the company lost out on the opportunity to raise more money to grow its business, because the IPO was mispriced (i.e., instead of receiving let’s say $30 a share from the public, it will have received only $20 a share).

In this scenario, if you were looking for short-term profits, great. If you are a long-term investor, however, a mispriced IPO may not be in your best interest.

Do your homework

Like any other investment, before making any decision regarding an IPO, you should review your investment goals and conduct a thorough analysis of the company, along with its growth prospects. There are distinctive risks associated with IPO investing, each IPO is unique, and it needs to be evaluated independently to determine its investment potential.

The IPO market is unique, and investing in it demands careful analysis.
2011 2012 2013 2014 2015
Number of Deals 125 128 222 275 170
Proceeds Raised (US$) $36.3B $42.7B $54.9B $85.3B $30.0B
Median Deal Size (US$) $160.2mm $124.0mm $126.3mm $100.0mm $93.8mm
Private Equity-Backed Deals 35 45 68 71 39
Private Equity-Backed Proceeds (US$) $20.4B $10.3B $24.5B $25.0B $11.3B
Venture Capital-Backed Deals 51 46 82 126 85
Venture Capital-Backed Proceeds (US$) $7.9B $20.7B $9.7B $35.3B $8.9B
Performance
Average US IPO Return* -9.8% 20.5% 40.8% 21.0% -2.1%
Avg. First-Day Return 10.5% 14.1% 17.3% 13.5% 14.3%
Avg. Aftermarket Return** -17.5% 5.6% 20.3% 7.2% 8.4%
Renaissance IPO Index -16.6% 17.6% 54.3% 7.2% -8.4%
S&P 500 0.0% 13.4% 29.6% 11.4% -0.7%
Russell 3000 -0.9% 14.0% 30.9% 10.4% -1.5%
Source: Renaissance Capital. Includes IPOs with a market cap of at least $50 million, and excludes closed-end funds and special-purpose acquisition companies (SPACs). Data through 12/31/15. *Calculated as average return from offer price to 12/31 close. **Calculated as average return from first-day close to 12/31 close.

Individual Fidelity investors can sign up to participate in an upcoming IPO (login required and there are eligibility requirements). However, one of the primary difficulties that retail investors face when it comes to researching companies that have not yet become public is access to information.

Publicly traded companies in the U.S., for example, are required by the Securities and Exchange Commission to disseminate financial information quarterly. Private companies are not required to do the same. Consequently, for the individual investor who does not have access to this information, it can be hard to fully assess the company’s merits as a sound investment.

One way that you might be able to navigate the intricate IPO waters is to consider investing with a fund or manager who has the resources to do the necessary research for a thorough analysis. Large investors like Fidelity have the research capabilities and resources needed to invest in the pre-IPO stage, which most individual investors are not able to do.

Learn more

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Views and opinions expressed may not necessarily reflect those of Fidelity Investments. These comments should not be viewed as a recommendation for or against any particular security or trading strategy. Views and opinions are subject to change at any time based on market and other conditions.
2. See note 1.
3. See note 1.
Past performance is no guarantee of future results.
There are risks associated with investing in a public offering, including unproven management, and in established companies that may have substantial debt. Investing in such companies may not be appropriate for every investor. Customers should read the offering prospectus carefully, and make their own determination as to whether an investment in the offering is consistent with their investment objectives, financial situation, and risk tolerance.
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