When should I snap up shares of an IPO?

Waiting for the price to settle after an initial public offering could be a good idea, unless it's underpriced right out of the gate.

Karen Wallace 20 March, 2017 | 5:00PM

Question: Is it a good idea to buy a company at its IPO? I've heard it's better to wait until the price settles down a bit.

Answer: As you allude to in your question, the oft-cited advice is to let the stock price "settle" after an initial public offering before taking the plunge; institutional investors' trading activity can cause an IPO stock to soar on its first day of trading, but this inflated price might not be sustainable.

Jay Ritter, a professor of finance at the University of Florida, looked at data from over 8,000 IPOs from 1980 to 2015 and found that the mean return of an IPO on its first day of trading is 18%. However, as Ritter's data again concludes, the three-year buy-and-hold returns of IPOs (assuming you bought an IPO on the first day and held it for three years) generally underperform the market, and are particularly poor for companies that have less than US$100 million in annual revenues. This lends credence to the conventional wisdom that buying IPOs on the first day of trading may not be a profitable strategy.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Facebook Inc A200.72 USD-4.50
Mastercard Inc A324.67 USD-4.42
Snap Inc Class A16.15 USD-3.29
Twitter Inc35.89 USD-6.32

About Author

Karen Wallace

Karen Wallace  Karen Wallace, CFP® is Morningstar’s director of investor education.