Originally Posted by iammatt
My understanding, and this is from a couple of years back because IPOs are not part of my strategy in any way, is that the average return from an IPO is no higher, and often lower, than the market itself. That said, sure, you can get some unwanted ones, and that isn't all bad, because the important metric is not how much something is worth, but the discrepancy, in your analysis, between the price and the value, or how your appraisal differs from that of the bankers. Still, I don't know that I would ever suggest the fact that something is an initial offering as a reason to buy, anymore than I ever understood a premium put on splits back in the roaring 90s.
This is incorrect, according to Ibbotson, Sindelar and Ritter (1994), the average IPO is underpriced by 15% meaning you get 15% abnormal return over the market from the IPO price. There are lots of arguments for why the underwriter (I-Bank) underprices the security for the IPO despite their incentive to overprice (they get 7% of the money raised). I don't really want to get into their incentives but they generally do underprice and they actually don't profit from it, at least not significantly unless they bear the risk of holding the security for themselves which most underwriters don't.
The reason the stock price goes up after IPO (for "good" companies) can be attributed to information asymmetry. Basically, outsiders don't know about the company whereas insiders (the company itself and the underwriters) know about the company. Once more and more credible/sophisticated investors invest into the company, the market realizes what the company is actually worth more so the price rises. This is basically the gist of one of the theories on information diffusion.