Question

Interpret the following statement made by Wall Street analysts and portfolio managers:

“IPOs transfer wealth from unsophisticated investors to large institutional investors who get in at the offer price and get out quickly.”

Answer 1

Initial public offering (IPO) refers to the process of offering shares of a corporation to the general public by new issue of stocks. IPO is done in order to raise capital from public investors. IPO is different from Offer for sale as in case of offer for sale, the company would not get any money raised from IPO , but it helps the exiting investor and they will get all the money. Practically, some companies combine the IPO and offer for sale to raise the capital and in order to relieve the invrestors who are exiting

IPO is generally made to raise the funds for the expansion plans of the company or sometimes it is made to only repay a debt and in such circumstance it is not such an attractive option.

The investors pay money while investing in an IPO and these investors are not as storng as the institutional investors in financial terms. So, the money invested by the unsophisticated investors transfers to company in the form of investment in the IPO and the institutional investors inturn sell off their part in the company post IPO in order to take advantage of the gains.

It has been witnessed that only very few of the IPO’s perform well after listing. This ratio is about 1:3 i.e. only one company out of three performs well in the long-term. This is because the company generally keep the offer price so high and the bidding lots are also in high quantities.

In such times, large institutional investors take advantage of the ‘IPO pop’ (i.e. monetizing on the premium listing of the stock on exchange) or 'Listing gains'. This is beacuse on listing, depending on demand and supply, there may be a surge in the stock prices which inturn enjoy listing gains. It has been generally observed that in the starting couple of weeks, the stocks move wildly, which helps the large institutional investors to take advantage of the opportunity available and make profits and leave.

As the ratio of successful IPO's is less so the institutional investors finds it advantageous to make profits just after the listing and leave whereas the unsophisticated or retail investors generally invests from long-term perspective. So, as the investors will realise later that stock is not performing well or not giving the expected return, till that time institutional investors had already sold off their stake.

It has been generally observed that only three in every 10 stocks deliver double-digit annual returns for a long-term IPO investor, five stocks deliver negative returns, and in case of remaining rest two, investors may have been better off parking their funds in safer fixed-income instruments. While comparing with the pitiful long-term prospects of IPO investments, the chances of making short-term returns are much higher which inturn is practised by Large institutional investors. So, the money invested by retail investors is inturn transferred to large large institutional investors.

So, it can be said that “IPOs transfer wealth from unsophisticated investors to large institutional investors who get in at the offer price and get out quickly.”