10 recent IPOs - and the lessons for investors

This summer's vote on whether or not the UK will leave the European Union has caused uncertainty in parts of the investment community. In particular, there has been a marked slowdown in the number of companies willing to press ahead with initial public offerings (IPOs).

Despite the lull, flotations are expected to resume in earnest later this year, with a number of prospective listings waiting on the sidelines. While this will be good news for companies looking to raise capital, it's worth remembering that the market's newest stocks present some unique challenges to investors.

A risky investment strategy?

From a statistical perspective, the average returns from relatively new listings simply aren't as good as those from companies with an established trading record.

Critics point out that investors and analysts just don't have a deep enough understanding of newly listed companies to know whether they are fairly priced or not. Indeed, it's hard to dispute the idea that the previous owners of these firms will only bring them to market when they're sure of fetching the highest possible price.

Research by Elroy Dimson and Paul Marsh at London Business School supports that view. They analysed 3,507 IPOs from 2000 to 2014 and found that the stocks often enjoyed a strong first day on the market. But, thereafter, the average returns were disappointing.

Specifically, the market value-weighted average first day return for investors who bought at the flotation price was 8.5%. Over the next two years, the average loss, adjusted for market movements, was 9.4%. More generally, the researchers found that investment returns are higher depending on the length of time that companies have been listed on the stock market.

A bullish approach to IPOs

Despite the statistical evidence against investing in IPOs, there are some investors with a much more bullish attitude. Robbie Burns, the "Naked Trader", is a big fan of new issues, noting that: "...looking back over 14 years of trading, some of my biggest winners have come from IPOs."

Giles Hargreave, who is widely regarded as one of the best small-cap growth investors in the UK, also believes that IPOs are an obvious place to look for investment.

He says: "Effectively, you wake up in the morning and assume that all the stocks in the market are correctly priced (of course they're not, but assume they are). Something else comes along so why would you buy it any more than you'd buy anything else that's on the market already?

"The only reason you'd do it is because they're cheaper. So by definition, IPOs have to be relatively cheap."

Analysing IPO performance

With this in mind, we took a snapshot of 10 IPOs from the past two years to see how they've performed. There is no science in the selection - there were over 110 IPOs during this period - but these were some of the biggest names to hit the radars of individual investors.

Apart from examining price changes, we've included details on how these stocks currently rank in the market according to their value and growth. Each rank blends some of the most insightful financial ratios and combines them to achieve a single-number score - the higher the better.

The standout finding from this selection is that the majority have outperformed the market. The best performer by a considerable distance is soft drink and mixer specialist, Fevertree Drinks, which has risen by 448% since flotation. Small-cap online holiday booking service On the Beach has also done well, with a 50% rise since its IPO in September 2015. And IT services business Softcat has excelled, with a 48% rise since last November.

The flies in the ointment, however, have been support service group Lakehouse and hire chain HSS Hire. A combination of boardroom bust-ups and multiple profit warnings have seen shares in these hit badly, down 63% and 53% respectively. Anyone investing in these two companies at IPO would probably be deterred from going anywhere near another new listing.

From a valuation point of view, most of these shares don't look particularly appealing. In fact, none of them have ever looked obviously cheap. But in part that might be understandable, given that newly-listed companies are often in a growth phase where current earnings are well below their future potential. The high GrowthRank scores here suggest that might be the case.

Even so, expensively priced shares that have seen their prices bid-up by the crowd can be dangerous territory. Any disappointments from relatively little known companies may well cause their prices to fall hard - as witnessed by Lakehouse and HSS Hire.

Overall, IPOs are a complex area for investors. Researching and valuing these companies in detail is challenging, yet this snapshot suggests that they can offer a rich seam of outperformance.

Ultimately it comes down to figuring out the growth potential and possible challenges, and judging whether the valuation offers enough incentive to get in from the start.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"