IPOs

An initial public offering (IPO) is the first time a private company sells shares to the public and lists them on a stock exchange. Companies go public to raise capital, give early investors and employees a way to sell, and gain the visibility of a public listing. IPOs often attract attention because of big first day moves, but research shows that newly listed companies have, on average, underperformed over the following years. Understanding the process helps traders separate hype from opportunity.

The IPO process#

IPO pricing and the first day pop#

Underwriters often price IPOs below what they expect the market to pay, so shares rise on the first day. Research by Jay Ritter at the University of Florida, covering thousands of US IPOs since 1980, found an average first day return of roughly 18% to 19%, with much higher averages during the 1999 to 2000 dot com bubble.

Long term performance#

Ritter's data shows that IPOs, on average, have underperformed comparable established companies over three to five years after listing, especially small, unprofitable companies and those listed during hot markets. There are notable exceptions, and averages hide wide variation.

Lockup periods#

Insiders and early investors usually agree not to sell for a set period, typically 180 days. When the lockup expires, a large supply of shares can become available to sell. Studies have found negative average returns around lockup expirations, similar to token unlocks in crypto. See Token Unlocks and Vesting.

Alternatives to traditional IPOs#

SPAC mergers boomed in 2020 and 2021, with more than 600 SPAC IPOs in 2021 alone. Many companies that went public through SPACs later traded far below their initial $10 reference price.

How traders approach IPOs#

• Wait for price discovery: many traders avoid the first days and look for setups after volatility settles.
• Read the S 1: revenue growth, losses, ownership, dual class shares and risk factors.
• Watch the lockup date and the first earnings report.
• Compare valuation with listed peers. See Comparable Companies and Precedent Transactions.
• Be wary of hype: heavy media coverage and retail enthusiasm often accompany peaks.

Risks#

• Limited public history and fewer analysts.
• High volatility in early trading.
• Insider selling after lockups.
• Dual class structures that limit shareholder voting power.
• Valuations driven by sentiment rather than fundamentals.

Frequently asked questions#

What is an IPO?#

An initial public offering, when a private company first sells shares to the public and lists them on a stock exchange.

Why do IPOs often jump on the first day?#

Underwriters tend to price shares below expected market demand to ensure a successful sale, leading to an average first day gain.

Are IPOs good investments?#

Research shows IPOs have underperformed comparable companies on average over three to five years, though some have been very successful.

Next, learn about companies selling more shares after listing in Secondary Offerings and Rights Offerings.

Sources#

• Jay R. Ritter, IPO data