Want to be notified when a new article is posted? Entere your email here.

Sunday, July 30, 2006

IPOs as a Predictor of Future Market Returns

Mark Hulbert of the NY Times discusses some recent research by Jay Ritter, who is far and away the most well respected academic currently studying IPOs. Ritter finds a correlation between IPO pricing and future market-wide returns:
Worldwide in June, more companies withdrew or postponed their initial public offerings than in any other month since March 2001, according to Dealogic, a firm based in London that monitors the new-issue market. That March 2001 trough came less than halfway through the 2000-2 bear market, leading many investors to worry that the current gloom in the new-issues market is a harbinger of much lower prices for stocks.

But the stock market'’s continuing decline in the months after the March 2001 I.P.O. bust was probably an anomaly, says Jay R. Ritter, a finance professor at the University of Florida who specializes in I.P.O. research.

An analysis of initial offerings market since 1980 suggests that, all else being equal over the next 12 months, the market between now and the summer of 2007 is likely to produce above-average returns.

Read the whole thing here.

It was difficult to find good data on the percentage of firms withdrawing IPOs back to the 80s. So what Ritter did instead is calculate the percentage of firms successfully going public in a given month with a final price below the midpoint of their offering range. He then related this percentage to subsequent stock market returns.

The basic logic behind the supposed relationship is that withdrawals of IPOs (or those that come in priced at the low end of their range) leads subsequent IPOs by other firms to be conservatively priced. A lot of low priced IPOs could serve as the impetus for subsequent higher market wide returns.

The relationship between the fraction of IPOs priced below midpoint and subseqeuent market returns is statistically significant at the 5% level (this means that association between the two variables would show up at these levels by random chance less than 5% of the time). So, it meets the cutoff statisticians typically use to determine whether it's significant.

Whether or not you can make money trading on it, who knows?

Note: Barry Ritholtz at the Big Picture has some interesting thoughts on the matter.

HT: Abnormal Returns.

No comments: