Warren Buffett: Why IPOs Can Be Painful for Investors

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During their latest episode of the VALUE: After Hours Podcast, Hasson, Taylor, and Carlisle discussed Warren Buffett: Why IPOs Can Be Painful for Investors. Here’s an excerpt from the episode:

Jake: There was actually a pretty clever study that was done of 16,000 US firms since 1975. What they did was they calculated the lifetime earnings and then compared that back to the IPO price.

So, this really is like that box of cash calculation, but run in reverse looking backwards like, how much earnings were there for the entirety of this company, and then what did it IPO at? How reasonably efficient is the market at ascertaining what’s it worth on day one versus the lifetime? They found that the two-thirds of the companies failed to generate sufficient earnings to justify day one stock price.

Kyler: Wow.

Tobias: Two-thirds?

Kyler: Undiscounted?

Jake: Well, they did discount. Yeah.

Kyler: Oh, okay. Yeah. Sorry, go ahead.

Jake: So, as Buffett has always warned, you got to be really, really careful with IPOs because naturally you’re at an informational disadvantage compared to the person who’s selling, which is typically the founders who know what’s going on, they know where the bodies are.

Tobias: Private equity VCs.

Jake: Totally. So, yeah, those are some stats for you to chew on for– [crosstalk]

Tobias: Priors confirmed. Good.

Jake: Yeah, all priors confirmed.


Kyler: Yeah, those are wild stats. I’ve always found it interesting that those statistics of 60% of the companies underperform T bills. Does that change how you invest? I’ve always found it’s hard to have too many conclusions from that.

Tobias: That was from IPO though, right?

Jake: Well, this is Bessembinder study of starting in whatever, 19– What did he– He did like that [crosstalk] onward.

Tobias: I thought there was some criticism of Bessembinder’s study.

Jake: There has been.

Tobias: [crosstalk] what it is.

Jake: I’m not smart enough to tell you exactly the ins and outs of it.

Tobias: I would say that it’s probably pretty good advice not to buy IPOs that’s probably– unless you have some–

Jake: I think [crosstalk] base rate, it’s probably not the best place to be fishing.

Tobias: Yeah. And then probably seasoned companies are a little bit better where they’ve actually shown an ability or in the very near future ability to generate some free cash flow, and then you need a management team– One of the things you said right at the start, Kyler, about being a negative process where you’re just excluding things that don’t meet particular criteria, that’s got to be the most efficient way of doing it. You just eliminate vast swathes of the market doing stuff like that.

Kyler: Yeah. I don’t think I’ve ever bought an IPO or close. I guess, I did one SPAC, and it turned out probably about how it should have, which was [Jake laughs] a 0% return through its buyout. I thought that was a real business, at least. Yeah, you know it’s funny. You probably shouldn’t be out buying stocks when it’s one of those hot IPO markets.

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