Do high-profile IPOs guarantee high-profile profits?

Stockopedia's Ben Hobson discusses the benefits of IPOs, some of the problems with them, and where to look for better performance.

When the food delivery giant Deliveroo (LSE:ROO) floated on the UK stock market earlier this year, it was one of the most anticipated tech IPOs that investors had seen for some time. 

Shares in the new listing were heavily promoted, both in the City and direct to the company’s own customers. But after just one month as a public stock, the original offer price of £3.90 had slumped by more than 40% to just £2.28. 

For those investors who bought in early, the Deliveroo IPO was a stinging lesson on how new large-cap listings offer no guarantee of making a profit. And while the company’s shares are now trading back at their original offer price, the rollercoaster experience will deter many from dabbling in IPOs again.

Who really wins from IPOs?

Initial Public Offerings are an essential part of financial markets, allowing companies to transition from private to public and unlocking precious access to capital. 

For existing investors (like founders and private equity backers), they can be a lucrative time to exit. For investment banks and advisers, they can be hugely profitable. For institutional investors, there’s the chance to secure early entry into new stocks at knockdown prices. 

But for individual investors, the benefits of IPOs are far less clear.

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This summer, a research team at Stockopedia examined the performance of 258 UK IPOs that took place between 2016 and 2021. The aim was to understand how they performed and whether there were trends in the results that could help private investors navigate this part of the market. 

One of the key findings was that high-profile, large-cap IPOs should be treated with caution.

This year we’ve seen a smattering of big names arrive on the London market, including the likes of Deliveroo, Darktrace (LSE:DARK), Dr Martens (LSE:DOCS) and Moonpig (LSE:MOON). Over time, big new listings tend to be infrequent and Stockopedia research shows their medium-term performance to be underwhelming. 

In the study, large-caps, on average, generated a negative performance in excess of -20% between one and two years after IPO. This raises questions about the heavy promotional activity around high-profile IPOs.

One theory is that the combination of aggressive IPO pricing by company advisers, together with heavy promotion to private investors, leads to excessive flotation prices that are prone to dropping back once trading commences. In these instances, the company valuation could be at risk of being stretched and the market quickly corrects it once the shares begin changing hands.

Better IPO performance lies in lower profile shares 

While high-profile, large-cap IPOs have had a habit of underperforming in recent years, it’s not all bad news. A key finding of the Stockopedia study was that IPOs in small-caps and micro-caps significantly outperformed their large-cap and mid-cap peers across almost all holding periods.

Over time, we found that small-caps lag slightly behind their more volatile micro-cap counterparts over shorter time frames, but take-off after about a year. Over five years, the average performance of small-cap IPOs reaches an impressive 85%, comfortably ahead of all other size groups. 

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Throughout the analysis, we found that smaller sized companies, which are often under researched, undercovered and underappreciated by the market, outperform on almost all metrics assessed. The small-cap and micro-cap groupings inevitably carry some higher risk, but appear to offer greater opportunity for capital gains and contain the vast majority of multibaggers.

So, for those toying with the ideas of buying shares in the next high-profile IPO, it’s worth considering who the big winners from the flotation will really be. With markets upbeat, it’s likely that new listings will begin flowing again in the coming months. It may be worth thinking carefully about which of them are really best placed to deliver positive returns.

If you’d like to read more about the performance of IPOs, you can read Stockopedia’s free IPO Survival Guide - which includes insights from a survey of interactive investor’s customers. You can download the full guide here.