Investor interest in initial public offerings (IPOs) picked up in 2023.
The IPO market tends to ebb and flow with the ups and downs of the stock market.
It’s important to be aware of both the opportunities and the risks associated with IPOs.
After a lull in initial public offering (IPO) activity, more headlines about several prominent new issues coming to market appeared in late summer 2023. Whether it signaled a sustainable upward trend is difficult to predict, but more IPOs coming to market appear to reflect renewed interest in this unique aspect of equity investing.
An IPO is the term used to describe the public issuance of stock by what was previously a privately held company. It is one way that private companies seek to raise equity capital. The company makes a percentage of its ownership available in the form of shares of stock on a public exchange. The stock’s price is set for the initial offering. Once the stock goes pubic, it is available to all individual investors.
IPO activity tends to peak during periods of strong equity market performance. “When stock markets are doing well, investors are receptive to high-growth companies so it’s a more favorable environment for new stock issuance,” says Kaush Amin, head of private market investing at U.S. Bank Wealth Management. “When stock markets struggle, as was the case in 2022, IPO activity tends to slow dramatically.”
As shown in the chart below, the historical record bears this out. According to this study, IPO activity – after reaching a two-decade high in 2021 – declined precipitously in 2022, as a bear market took hold. 2022 IPOs dropped to the lowest level since 2008 (another significantly negative year for the stock market).
“When interest rates began moving higher in 2022, perceptions changed,” says Amin. “Investors turned their focus to stocks of companies that could generate current earnings and put less faith in stocks of companies that mainly promoted the prospects of future earnings. Most IPOs would fall into the latter category.”
Activity in the IPO market has since picked up as equity and fixed income markets have rallied this year, with more than 70 occurring as of mid-September 2023.2 Among the most prominent names were British semiconductor and software design company Arm Holdings; the marketing automation technology firm Klaviyo; and the grocery delivery company Instacart.
IPOs often garner significant media attention, particularly when better known or highly successful private companies choose to go public. Investors take an interest as they see a stock that has just been offered on the public markets as a “ground floor” investment opportunity.
“Individual investors should realize that they are not specifically buying the initial public offering,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Even if an investor buys the stock on the first day it becomes available, it technically means they’re buying the stock on the secondary market, after the IPO already occurred.” Large underwriting syndicates, and sometimes select brokerage firms, typically have exclusive access to shares from the IPO issuer.
“The early days of trading [in a new IPO] can be very speculative. The real value becomes more apparent six months after the initial offering.”
Kaush Amin, head of private market investing at U.S. Bank Wealth Management
While investors may have a desire to own stocks as quickly as they come to market, a reasonable concern is whether that’s appropriate for a long-term investment strategy. “For many individuals, it makes sense to give these stocks time before investing,” says Amin. He notes that once a stock goes public, there’s a 180-day lockup period that restricts private investors in the company from selling shares. “Once that lockup period expires, you’ll have a better sense of private investors’ sentiment about the company’s outlook,” says Amin. If many private investors put their shares on the market when the lockup period expires, it may reflect a lack of confidence in the company’s future prospects. If instead more of those investors hold onto their stock, it may indicate their expectation of future share price appreciation. That would be a positive sign to other investors.
Haworth points out that companies from all industry sectors go public, with no discernible trend indicating which tend to perform best over time. “It’s really a company-by-company situation,” says Haworth. “Certain environments may favor certain types of stocks, but there’s no particular advantage a specific industry has demonstrated over time.”
Based on at least one recognized measure, IPO performance has fluctuated over time. An exchange-traded fund (ETF) known as the Renaissance IPO ETF, invests in newly issued stock. The fund holds IPO issues for no more than three years after they go public.
The fund’s share price gained 34% in 2019 and 108% in 2020, before experiencing declines of 10% in 2021 and 57% in 2022. The fund rebounded in 2023. Through September 26, its share price was up more than 25% for the year.2
The performance of individual IPO issues will vary widely with the results of the Renaissance ETF fund. To demonstrate the potential volatility of new IPOs, consider the experience of Arm Holdings in the first days after its IPO. When Arm’s stock went public on September 14 priced at $51/share, its price jumped to more than $65/share during the next trading day. However, by September 21, the price was below its initial offering price of $51/share. It since recovered modestly, but far from its peak price of the first two days of trading.2 It reflects the unpredictable, short-term nature of new issue pricing. Haworth notes that the day an IPO first hits the market “is often the peak of enthusiasm for the stock, and the environment often becomes more challenging thereafter.”
A longer-term trend common with IPOs, adds Amin, “is that we see newly issued stocks rise faster than the broader market in a bull market, but also potentially decline more rapidly than stocks as a whole in a declining market.”
IPOs offer a combination of opportunities and challenges. Some companies that demonstrate an ability to grow consistently over time may generate favorable returns for investors who are able to take advantage of the new issuance of stock. That is the goal many investors have in mind when they invest in new issues. However, that scenario doesn’t always play out.
“One challenge for investors with an interest in IPOs is that they have to try to do research on a company that’s been privately held,” says Haworth. “Without the kind of readily available information that must be disclosed by public companies, it can be difficult to discern the quality and value of the stock.” Haworth urges investors to carefully assess how any IPO investment might fit in with their overall portfolio strategy.
Amin reiterates the importance of exercising patience before investing in IPOs. “The early days of trading can be very speculative. The real value becomes more apparent six months after the initial offering,” says Amin. “You want to be sure the firm has a track record of profitability and a path toward future growth as you evaluate the merits of an individual stock for your portfolio.”
Because of their limited track record, IPOs can be more speculative than established stocks. Before investing, talk with your wealth professional about how new issues in the IPO market may benefit your long-term investment strategy.
It’s easy to get caught up in the excitement surrounding IPOs. Review these common misconceptions before investing.
Hedge funds are alternative investments for diversifying and potentially enhancing investor portfolios. Review the risks, benefits and investment strategies specific to hedge funds.