Dan Solin's Newsletter, March 9, 2017

The financial media was in a frenzy with news of Snapchat’s initial public offering. The stock soared 45 percent in short order. Who wouldn’t want a piece of those gains?

Before you’re tempted to get on the bandwagon and buy Snapchat or any other IPO stock in the secondary market, take a look at the data. Studies of IPO performance are not encouraging. One study looked at the period from 1970-2010. The author compared the returns of IPOs to similar listed stocks. He found significant underperformance of the IPO stocks. Investors would have been far better off buying comparable listed stocks.

Why do investors find IPO stocks so appealing? As Larry Swedroe explains in this blog post, “…they're willing to accept a high probability of a below-average return to have the small chance of earning an outsized return if they find they next Google.”

Most investors are not able to get an allocation of stock at the IPO price. The big gains you read about almost always reflect an increase in price over the IPO price. When you understand the performance of these stocks after the bounce occurs, you’ll avoid them.