Why IPOs have not been great investments

IPOs might outperform in their first year but fail over the longer term according to top fund manager

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Companies listing on the ASX tend to outperform the rest of the market in the first year, but over the long term tend to fail.

That's the view of Allan Gray managing director Simon Mawhinney after the fund manager analysed all IPOs over the last decade with market caps greater than $2 million. 7 of the worst ten performing companies in 2016 were businesses that listed in the past three years.

A number even failed to pass their three-year anniversary, including electronics retailer Dick Smith Holdings, training provider Vocational Education and trucking company McAleese.

Mr Mawhinney says IPO companies tend to outperform the market in their first year, but performance tails off after that as the years pass. "They are priced for perfection. Most newly listed companies come to market when either economic times or just stock markets, in general, are incredibly buoyant and are more receptive to new listings," he has told Fairfax Media.

That's not always the case of course, with several IPOs tanking in their first 12 (or so) months. Wellard Ltd (ASX: WLD) – a livestock marketing, export and transportation company has lost 85% of its value since the start of 2016. It listed in December 2015.

There are plenty of examples of IPOs from within the past three years that have tumbled, but remain listed.

Building company Simonds Group Ltd (ASX: SIO) listed in late 2014 with an issue price of $1.78 and had seen its share price sink to just 38 cents. It was one of the worst-performing shares in the 2016 financial year. The company now appears to be looking to delist from the ASX.

Surfstitch Group Ltd (ASX: SRF) issued shares in its December 2014 IPO at $1.00 each. After soaring to a high of $2.13 in November 2015, the share price has crashed to as low as 10 cents. Shares currently trade at 19.5 cents.

It remains to be seen whether the above-mentioned companies can turn around their share price performance in the years ahead, but it's another warning to investors looking for those 'stag profits' in IPOs. Performance over the longer term counts more, and IPOs are not the best way to play that.

Foolish takeaway

No wonder the world's greatest investor, Warren Buffett, is not a big fan of investing in IPOs and recommends investors avoid them. Investors should remember his words, "It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)."

  Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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