Why these investments are a great strategy

IPOs have consistently outperformed the market but as with any stock-picking strategy, it involves some risk. When you take a portfolio approach to IPO investing, not only can you minimise that risk, but you can make some great returns too. In 2015, IPOs returned investors an average of 25 per cent. That’s an asset class worth looking into.

There’s something about being offered access to an IPO that might remind you of taking your first dive into a swimming pool. Is it going to be cold? Are you going to flail then drop like a rock to the bottom of the pool and become an unfortunate statistic?

If you’re only going to buy into one IPO then yes, there’s inevitably some risk, but if you buy into more than one, the risk drops away dramatically. To be specific, if you’d bought into every IPO in Australia in the last ten years you’d have enjoyed an average 15 per cent return on the first day.

By today’s low growth, low return standards that is a truly impressive statistic.

Of course, this is simply a hypothetical scenario since there have been more than 1,000 IPOs in that time and no-one has time to study prospectuses all day, never mind actually get access to them, which has been a challenge for ordinary investors for as long as IPOs have been around. But it does show two things:

1. The risk minimisation issue.

2. Every investor should be looking closely at those IPO returns, in the context of which other asset class would even get them close to that.

That 15 per cent return isn’t an annual number. It does represent a rough number you can expect to make by way of a capital gain between the time you apply for shares and the time the proceeds drop into your trading account, if you sell on Day One.

How long is that? If you get a late allocation, it might be a week. But more commonly you should assume it could take a month. Meaning, if you were a very well organised investor with a very steady flow of IPOs to get into, you could make many times that return over the course of a year.

Another way to look at smoothing your risk is to consider that buying into IPOs is not some gamble where you are betting against the house: you are buying far more options than that.

You can decide for yourself whether your foray into IPOs is a marathon or a sprint.

Investing in IPOs as a number of inbuilt advantages.

Advantage one: The float promoters want to attract investors and the time honoured way is to apply some sort of discount to the issue.

Advantage two: The simple fact that shares go from being untradeable to tradeable with the ringing of a bell on float day means that they automatically become more desirable.

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Of course there are mispriced floats out there. Promoters and vendors can get greedy and market conditions vary between ‘red hot’ and ‘outright terrible’ but it is safe to say that the majority of IPOs are well priced. And I haven’t even mentioned ‘blue sky’ and the chance to get a really significant return on your investment.

Bearing in mind that the most you can lose is your original stake, some of the long term returns of sharemarket investing have been quite dazzling. Here are three good examples:

Scenario 1: Say you bought into Commonwealth Bank when it was privatised in 1991 at $6.75 a share. Those shares are now worth around $75 each. Putting aside the generous dividends that have been paid in the interim, you’d be up more than ten times on your original investment.

Scenario 2: Or you bought into Cochlear, the hearing specialist listed in 1995 at $2.90 a share. Again ignoring dividends, you’d be up almost 50 times on your original stake given the shares are now worth more than $140 each. They are good examples of the joys of long term investing but you can also get very good returns over short periods if all goes well.

Scenario 3: Bellamys Australia Ltd, the dairy products company, listed a year ago in August 2015 at $1 a share and those shares are now worth around $15 each.

As they say in the US: “You do the math.”

Have you considered investing in IPOs? Let us know in the comments below.