December 12, 2019

IPOs – High Profiles, Low Returns – Following the Evidence

One of the benefits derived from the evidence-based investment approach is the systematic avoidance of underperforming investment strategies.  Media narratives and marketing drive many of these strategies, that while they might help increase advertising sales and commissions, do little to help investors develop successful investment portfolios.

One such currently popular strategy is investing in newly available Initial Public Offerings (IPOs).

Before jumping into the latest IPO, investors should ask the following three questions:

  • What is the investment case around investing in IPOs?
  • Does the evidence support the idea that these types of investments outperform the broad market without added risk?
  • What are the drivers of IPO performance?

Recent research from Dimensional Fund Advisors helps answer these questions.

The IPO Investment Case

Several well-known disruptive firms such as Lyft, Uber, Peleton and Zoom have gathered significant media and investor interest around their IPOs. The general narrative around these high-profile names is that they are high-growth, industry changing firms that investors would be lucky to have access to.  However, investors should also consider issues around competition and how the newly public companies will be able to maintain their front runner status.  Equally important is awareness of the difference between a ‘good’ company and a ‘good’ stock.  We can define a good company as one in which the firm’s products and/or services are in great demand.  We can then define a ‘good’ stock as one that outperforms the overall market over some time period.  While always the case, it is especially true with IPOs, that investing in the stock of ‘good’ companies does not necessarily lead to outperformance.

The Evidence

Dimensional analyzed the performance of over 6,000 IPOs over the period from 1991 – 2018.  Overall, they found that a hypothetical portfolio of IPOs significantly underperformed standard equity benchmarks.  The table below compares the returns of a hypothetical IPO portfolio to the Russell 3000 index (a measure that tracks the performance of the broad U.S. stock market) and the Russell 2000 (a measure that tracks the performance of small U.S. company stocks).  Over the full period analyzed, the IPO portfolio underperformed both the broad market and small companies by over 2% per year.

IPO Returns, 1992-2018

Annualized compound return 1992-2018 1992-2000 2001-2018
Hypothetical Portfolio of IPOs 6.93% 13.63% 3.74%
Russell 3000 Index 9.13% 15.70% 5.98%
Russell 2000 Index 9.02% 12.56% 7.29%

Past performance does not guarantee future results.
Source: Dimensional using Bloomberg data. The sample includes US market IPOs, including US-domiciled companies and foreign-domiciled IPOs in the US, with an offering date between January 1, 1991, to December 31, 2018. Excluded from the sample are IPOs with an offer price below $5, unit IPOs (common stock and warrants), and IPOs involving real estate investment trusts, closed-end funds, American depository receipts, partnerships, and acquisition companies. The hypothetical IPO portfolio is formed December 31, 1991, and is rebalanced monthly to include all firms with an IPO during the prior 12-month period. Weights are based on prior month-end market capitalization. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indices. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.


Drivers of IPO Performance

The last question explores why IPOs underperform market indices.  By analyzing IPOs with standard asset pricing models, the drivers of IPO underperformance can be understood.  Academic research has identified specific equity factors that drive equity returns.  The table below highlights the known drivers of equity returns and the IPO portfolio factors.  Through this analysis, we can understand why IPOs generally underperform broad equity markets.

Factor Higher Expected Return Lower Expected Return IPO Portfolio Factors
Price Value Growth Growth
Size Small Large Small
Profitability High Low Low
Investment Low High High


According to the Dimensional paper, “IPOs have underperformed the market because, as a group, they have behaved like small growth, low profitability, high investment stocks, which have had lower expected returns than the market.


The evidence-based approach to investing guards investors from jumping into underperforming investment strategies.  By applying a disciplined investment approach that includes understanding the investment case and analyzing the evidence, we can weed out strategies that are creations of media and marketing, leaving us with academically-backed investment portfolios.  In the case of IPO investing, remember, ‘don’t believe the hype’.