IPO: What Happens When a Company Goes Public – and What Data Shows About the First Years

Imagine the moment. You're sitting at your computer, watching the ticker, and suddenly a name appears that has been talked about for months. The stock of a company that was previously private is now being traded on the stock exchange. The excitement is palpable, expectations are high. Is it a chance to "ride" the wave of growth, or rather a trap for naive investors? Going public, or an Initial Public Offering (IPO), is an event full of hope for both the company and investors, but also hidden risks.

The Big Day: What Happens Behind the Scenes of an IPO

When a company decides to go public, it is usually the culmination of years of work and growth. The goal is to raise capital for further expansion, pay off debts, or allow existing shareholders (founders, venture capital funds) to sell part of their shares and realize a profit. The entire process is complex and takes months, sometimes longer.

The company hires investment banks (known as underwriters) to help with the entire process. These banks conduct due diligence, value the company, and determine the initial stock price. This is followed by a "roadshow," where the company's management and underwriters present the company to large institutional investors (pension funds, hedge funds) and try to convince them to buy shares. They then submit their "bids," and based on their interest, the final offering price is set.

The IPO itself is the day when the shares are first traded on the public market. We often see that the stock price on the first day of trading rises significantly compared to the offering price. This is due to high demand and limited supply. For example, in 2021, which was a very strong year for IPOs, the average gain on the first day of trading was approximately 30–40%.

Why Is the First Day So Volatile? The Role of "Underpricing"

The phenomenon where the stock price on the first day of trading significantly exceeds the offering price is called "underpricing." Why does this happen? Investment banks are interested in ensuring the IPO is successful and the shares sell well. Slightly undervaluing the price ensures strong demand and positive sentiment. For institutional investors who receive shares at the offering price, it's a quick profit. For the company itself, it means they raised less capital than they could have, but on the other hand, it builds a positive image and interest in their shares for the future.

For retail investors, however, access to shares at the offering price is almost impossible. They usually get them only on the trading day when the price is inflated. This creates the impression of a "quick profit," which is often just an illusion for those who buy later.

What Does the Data Show About the First Years After an IPO?

While the first day of trading can be euphoric for some investors, long-term data shows a different picture. Studies from various periods and markets agree that the performance of companies after an IPO in the first 3–5 years often lags behind the broader market or comparable companies.

For example, an analysis conducted by Jay Ritter, a finance professor at the University of Florida, showed that in the USA from 1980–2018, IPO companies on average lagged behind comparable firms by approximately 20–30% during the first three years after going public. Similar results have been found in studies for European markets.

Why does this happen?

* Exaggerated expectations: Companies going public are often in the early stages of growth, with high ambitions and big promises. The market may value them very optimistically on the IPO day, but the reality of growth and profitability may turn out to be slower than expected.
* Loss of competitive advantage: Some companies lose part of their agility and innovativeness after an IPO, which they had as private entities. Public scrutiny and pressure for quarterly results can lead to less risk-taking and a shorter investment horizon.
* Sale of shares by existing shareholders: After the expiration of the "lock-up" period (usually 90–180 days, during which existing shareholders cannot sell their shares), a large number of shares may be sold, creating pressure on the price.
* High IPO costs: The IPO process itself is very expensive, with fees to investment banks ranging from 5–7% of the capital raised. These costs reduce the efficiency of the raised capital.

This does not mean that all IPOs are a bad investment. There are, of course, exceptions that have become huge successes. But statistically, the risk of underperformance in the first years after an IPO is higher.

Practical Framework for Investors: How to Approach IPOs

If you're tempted to invest in an IPO, here are some practical steps to help reduce risk and increase your chances of success:

1. Don't buy just because of the "hype": The first day of trading is often full of emotions. Ignore the media noise and focus on the company's fundamentals. Is it a company you would invest in even if it had been on the stock exchange for five years?
2. Thoroughly study the prospectus (S-1/F-1): This document contains detailed information about the company, its business, financial results, management, and risks. Take the time to read it. Look for warning signs such as high debts, declining margins, or dependence on a few key customers.
3. Evaluate the valuation: What is the current valuation of the company? Compare it with similar publicly traded companies. Is the stock price realistic given the potential for growth and profitability? IPOs are often priced at a premium.
4. Consider the "lock-up" period: Be aware of when the "lock-up" period for existing shareholders expires. This could be a point when a large number of shares hit the market and the price may drop.
5. Long-term horizon: If you decide to invest, approach the IPO as a long-term investment. Short-term speculation is highly risky. Give the company time to execute its plans.
6. Diversification: Never bet everything on one card, let alone one IPO. Diversification of your portfolio is key to managing risk.

QMA Hook: Filtering Quality Even Among Newcomers

Identifying a quality company with sustainable growth from one that is just inflated by "hype" is challenging even for established companies, let alone newcomers to the stock exchange. At QMA, we focus on robust fundamental analysis that helps identify companies with solid foundations and potential for long-term growth. Our screener allows filtering companies based on dozens of criteria, such as profitability, revenue growth, debt, or free cash flow. Even though IPO companies do not have a long history of public data, their available financial statements can be analyzed and compared with benchmarks. QMA thus helps investors focus on data and not emotions, even in the dynamic world of IPOs, where an objective view is especially valuable.

Takeaways

* IPO is an event with high volatility: The first day of trading often brings significant price movements, but these may not reflect the long-term value of the company.
* Data warns of underperformance: Historically, many IPO companies lag behind the broader market in the first years after going public. Be cautious and don't get carried away by initial enthusiasm.
* Thorough analysis is key: Before investing in an IPO, study the prospectus, evaluate the valuation, and focus on the company's fundamentals, not speculation.
* Long-term horizon and diversification: Approach IPOs as long-term investments and always diversify your portfolio to reduce risk.

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Compliance Disclaimer: This article is for informational purposes only and does not constitute investment advice. Always conduct your own research or consult with a financial advisor before making investment decisions.