Best Way to Trade Stock IPOs

Looking at stocks that skyrocket vs. slow-roll to double their IPO price

Senior Quantitative Analyst
Oct 16, 2019 at 6:30 AM
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When you track stocks as closely as we do, sometimes you'll see a narrative play out several times. Traders have identified many popular patterns that seem to happen regularly enough that they make trades (or confirm trades) based on them. For example, a head-and-shoulders pattern, a double top, etc. These chart-based patterns are easier to see than quantify, so testing them is difficult. Hence the motto that trading is more of an art than a science.

One pattern we've noticed is that stocks have an uncanny tendency to stall or reverse at even initial public offering (IPO) levels -- for example, double their IPO price. Our theory is that these levels are important psychological points for the stock. Perhaps early investors habitually take profits at these levels. Or it might be that investors emotionally attach the "expensive" label to a stock at these levels. Another possibility is that it's selective memory. Maybe it just sticks in our brain when we see it, and when the counter-narrative happens we forget it. It's a common error.

IPO Doublers on Day One

Unlike chart patterns, IPO levels are easy to quantify. We've been tracking the more notable IPOs for some time now. Specifically, since 2010, we have 127 companies along with their IPO prices. I'll use these stocks to quantify how they perform when running into double the IPO price. 

I think there's a difference between stocks that grind up to double the IPO level and ones that deliver triple-digit returns on Day One. So, I first looked at stocks that reached a high above their IPO price or close to it (within 2%) on the first day of trading. Then I found the stock returns going forward from the next day to three months. Eighteen stocks accomplished this, and I summarize their returns going forward below.

For studies like these, where there are different types of stocks and different time periods and trading environments, I believe the best metric to use is the percentage of stocks that beat the broader market. I bolded this stat, which is the last row of the table. These stocks that are hot out of the gate tend to underperform longer term.

Now, I can't say if this is directly a result of it being near a 100% gain, because this study included stocks that jumped well above that level. But it does suggest that buying hot IPOs on the first day at big gains might not be worth it. Buying the S&P 500 Index (SPX) wins just as often and is much less risky. However, doing this would have resulted in gains as the average stock return over the next three months was nearly 12%. The average was buoyed by a couple large returns though.

IotW 1 IPO doublers Day 1

Stocks That Doubled Their IPO Price in 6 Months

This next table shows stocks that quickly reached a double, but not quite on Day One. These are stocks that got within 2% of double their IPO price in the first six months of trading. The S&P 500 Index often beat these stocks going forward.

To me, the numbers support our theory that 2x the IPO price is some sort of barrier or speed bump for a stock. A month after these stocks got to this level, they beat the market only about 30% of the time, and averaged a loss of 5%. The longer-term returns were better, with a big average return over the next three months (again, skewed by some big returns), a 51% win rate, and almost 45% beating the broader market. In other words, it's possible the psychological 100% IPO return level hinders even fundamentally strong stocks which eventually reach fair value after the IPO-multiple speed bump.

IotW 2 IPO doublers six months

Slow-Burning IPO Doublers

Finally, here are the results of stocks that took a little longer (more than six months) to double their IPO level. These stocks underperformed in the short term as well, but were much more bullish longer term. The returns are awful over the next week after hitting a 100% return off the IPO, losing an average of 1.5% and only a third of them beating the S&P 500 Index. These stocks were bullish, however, at two weeks and after.

Again, the theory is these are fundamentally strong stocks grinding toward fair value that get unjustly sold off when at their double IPO price. After the profits are taken, the stock outperforms to catch back up to fair value. Perhaps there's a way to profit twice: sell when it reaches a double and buy two weeks later.

IotW 3 IPO doublers late

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