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IPO Long-Term Underperformance

IPO Long-Term Underperformance. Sara Purisky. Anomaly Background. IPOs tend to underperform in the first 3-5 years Investors are often too optimistic about new equity issues  inflated prices Market corrects the price Leads to a decrease in returns over time.

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IPO Long-Term Underperformance

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  1. IPO Long-Term Underperformance Sara Purisky

  2. Anomaly Background • IPOs tend to underperform in the first 3-5 years • Investors are often too optimistic about new equity issues  inflated prices • Market corrects the price • Leads to a decrease in returns over time

  3. Article #1: Loughran and Ritter (1995) • Hypothesis: In comparison to non-IPOs, IPOs will underperform in the first 5 years. • Data: 4,753 U.S. IPOs between 1970 and 1990 • Looked at company returns from IPO to 5-year anniversary • Matched each IPO firm with a non-IPO firm • Non-IPO firm = no new stock issues for 5 years

  4. Article #1: Loughran and Ritter (1995) Results: • Average annual returns for company 5 years after IPO: 5% • Average annual return for non-IPO companies over 5 years: 12% • IPOs tend to increase their returns in the fifth year (Loughran and Ritter,1995, p. 34)

  5. Recommendation from Article #1 • SHORT IPOs in first 3-4 years • 5th year begins to see higher returns, so close position by then • Wait until after first week of IPO • Difficult to gain access to IPOs in primary market • IPOs tend to have positive returns in first day of trading

  6. Article #2: Guo, Lev, and Shi (2006) • Hypothesis: R&D spending can be used to predict IPO performance. • Data: 2,696 U.S. IPOs between 1980 and 1995 • R&D expenses from income statement • Returns over three years after the IPO

  7. Article #2: Guo, Lev, and Shi (2006) • Results: • R&D spending and long-term returns have positive relationship • IPOs with high R&D perform better than firms with low R&D • Firms with any R&D spending outperform firms with no R&D • Firms with high R&D tend to have less over optimism at IPO—priced more fairly

  8. Recommendation from Article #2 • LONG: Firms with higher R&D spending in year prior to IPO • SHORT: Firms with no R&D spending in year before IPO • When following these guidelines, Guo, Lev, and Shi (2006) found 7-9% excess returns in 3 years after IPO

  9. Conclusion Based both articles, I recommend: • SHORTING IPOs in their first 3-4 years, UNLESS they had very high R&D spending in the year prior to the IPO • Hold shorts until 4th year of IPO—tend to increase returns in 5th year • LONGING the IPO if firm has high R&D spending • Tend to outperform other IPOs • Can hold longer than 5 years– want returns to increase

  10. Questions?

  11. References • Guo, R., Baruch, L., Shi, C., (2006). Explaining the Short- and Long-Term IPO Anomalies in the US by R&D. Journal of Business Finance & Accounting. 33(3-4), 550-579. Retrieved from http:// onlinelibrary.wiley.com/doi/10.1111/j. 1468-5957.2006.00610.x/abstract • Loughran, T., Ritter, J. (1995). The New Issues Puzzle. The Journal of Finance. 50(1), 23-51. Retrieved from http://bear.warrington.ufl.edu/ritter/ newissuespuzzle.pdf

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