Investing in Facebook: An IPO for Fools?
Investing in the Facebook IPO may not get you the returns you are looking for in the long run.
Investing in the Facebook IPO may not get you the returns you are looking for in the long run.
After years of speculation, the social networking site Facebook has announced its intention to go public. Without a doubt, this is the most highly anticipated initial public offering in the technology sector since Google went public in 2004. But now comes the question: should you invest? According to extensive academic research, investing in IPOs is not necessarily a good idea.
Tarun Ramadorai, a professor at the Saïd Business School at the University of Oxford, has studied IPO data extensively. According to these studies, having a buy-and-hold mentality with IPOs is inefficient. It is much better to buy the shares initially and then dump them after a few months, or buy shares in their competitors, he says.
The data shows that shares in newly-IPO'ed companies tend to rally in the first day of trading, and then over 6 to twelve months, the company's shares perform well relative to similar companies, says Ramadorai. But, on average, the evidence shows that comparable companies will outperform IPO'ed companies by a substantial margin over the long run, he says.
“If you constructed a portfolio of companies with similar characteristics, then IPOs have been shown to underperform this portfolio,” he says.
For example, buying a portfolio of other large tech companies such a Google (GOOG) and Apple (AAPL) would, in general, be a better long-term investment idea than buying and holding onto shares in Facebook.
That is not to say that IPO'ed companies perform poorly; they simply do not perform as well as their peers.
Professor Jay Ritter at the University of Florida has collected data on 8,670 U.S. companies that had IPOs between 1970 until 2009. This is what the data shows, on average:
Ramadorai says there are two main theories about why these companies underperform their peers. The first theory is based on the idea that when the management of a private company want to issue equity and go public, they will only go to the market when the company’s valuation is reaching a peak in order to get the best deal for themselves. “That means there’s a valuation trough coming up because you can’t get any higher than the peak,” says Ramadorai. The second theory revolves around the idea that investors overreact to IPOs. Investors generally become excited and bid the shares above a sensible valuation. Then when emotions cool off, investors realise the company has become overvalued and the shares will drop.
So how can you take advantage of this trend? “I’d try to get my hands on the IPO to begin with and then sell it after 6 months,” says Ramadorai.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.