In this session, we look at the process by which private businesses enter the public market place and whether investors can exploit frictions in that process to generate higher returns. We begin by describing the sequence of an initial public offering, from the investment banking underwriting agreement to the final offering date. We then examine the behavior of IPOs on the offering date, where, at least on average, the stock price jumps about 10-15% from the offering price. Trying to capture this “under pricing “ is difficult for investors to do for three reasons: a selection bias, where you tend to be over invested in over priced IPOs and under invested in under priced ones, a “hot and cold” markets problem, where you find almost nothing to invest in during cold IPO periods and too many choices in hot periods and a post-issue timing quandary, where you can lose most of your profits if you hold an IPO too long. We conclude on an optimistic note, by looking at ways you can modify the strategy to counter all three problems.
