Initial public offerings (IPOs) provide an opportunity for the public to buy when a company lists its shares on a stock exchange for the first time.

Plenty of examples exist where a successful IPO has delivered immediate share price gains for investors.

But it’s not always plain sailing. There are also many instances where an IPO has left shareholders nursing substantial losses, thanks to a plunging share price once public trading has begun.

Last year was a bumper time for IPOs on the London Stock Exchange (LSE). In contrast, the testing market conditions of 2022 mean that activity has fallen off a cliff this year.

That said, Volkswagen, the German car manufacturer, managed to defy the gloom last month with a multi-billion euro IPO for its Porsche subsidiary.

Here’s a closer look at IPOs, including, the potential benefits and risks for investors, plus a look how some recently-floated UK companies have performed.

Investment is speculative and your capital is at risk. You may lose some or all of your money.

What is an IPO?

An IPO is the process through which a private company first offers its shares to the public.

The newly-issued shares are listed on a stock exchange such as the LSE or the NASDAQ in the US. The process is often referred to as ‘going public’ or ‘floating’.

There are a number of reasons why a company might choose to carry out an IPO. For example, a flotation provides the opportunity for existing investors, including founders and employees, to sell a portion of their shares.

It also allows corporate backers, such as private equity firms, to cash out their investments.

Companies may also choose to float to raise additional capital for expansion and acquisitions, and/or to reduce debt. Companies boost their profile by ‘going public’ and can secure preferential terms on borrowing.

At the same time, public companies face more scrutiny and additional regulations such as disclosure requirements and reporting of results.

They will also need shareholder approval for corporate activity including setting executive pay and proposed disposals or acquisitions.

IPOs are often priced keenly to ensure that the issue of shares is fully subscribed, and to reward investors with a rise in share price on the first day of trading.

There is usually a ‘lock-up’ period of 90 to 180 days during which existing and large investors are prevented from selling their shares to provide support for the share price in the early days of trading.

How have recent IPOs performed?

Luxury car maker Porsche recently made its stock market debut by listing on the Frankfurt Stock Exchange at a valuation of €75 billion – a record for a European IPO.

The IPO price of €82.50 per share was near the top end of the valuation range and allowed parent company Volkswagen to cash in part of its stake.

Despite difficult prevailing stock market conditions, Porsche’s share price has held up well so far, with shareholders sitting on gains of around 6% at the start of October 2022.

However, the picture has been much less rosy for the wider IPO market this year.

According to consultants Edison Group, the majority of IPOs launched since the start of 2020 in both the US and Europe are trading below their issue price, with half having fallen by at least 50%.

The following table shows the subsequent share price performance of some of the better-known companies that have floated on the LSE since last year.

With the exception of food delivery company Deliveroo, all of the IPO investors could have made a substantial profit had they sold at the highest share price, typically at around six months post the IPO.

However, against a background of falling stock markets and wider macroeconomic concerns, all of the shares except technology company Darktrace are currently trading some way below their IPO price.

In the case of online card retailer Moonpig, Deliveroo, and consumer review site Trustpilot, shareholders investing at the IPO stage will currently have lost more than half the value of their initial investment.

The worst IPO casualty is Deliveroo, whose share price dropped by more than a quarter on its first day of trading alone. The company has faced a perfect storm of corporate issues, from a dispute over rider pay to a dip in demand since the end of lockdowns.

The IPO of cyber security firm Darktrace has been more successful for investors, with a near quadrupling of its share price by September 2021. Although its share price has subsequently fallen, investors are currently sitting on a post-IPO gain of around 20%.

Why have these newly-floated companies struggled to justify their IPO valuations? Mainly, it’s down to wider economic issues that have forced stock markets to fall in the last year, due to high inflation, rising interest rates and geopolitical issues.

The market downturn, together with high volatility, has reduced investor appetite for newly-floated companies which are seen as higher-risk investments due to their shorter public track record.

Should you invest in an IPO?

Danni Hewson, financial analyst at trading platform AJ Bell, offered these thoughts to investors considering whether to invest in an IPO: “IPOs generate headlines and excitement. They can also create an immediate ‘pop’ for investors, a quick jump in share price on day one, which is why there has been such a big push to get retail investors more access to this part of the market.”

But Ms Hewson says there are downsides to consider as well. “There’s a common theory that the pop is created because IPOs are priced at a discount to incentivise investors to put their money into companies with no track record as a listed business.

“There have been plenty of examples over the past year of market darlings that morph into cautionary tales once the dust settles.”

Investment experts say investors need to apply the same strategy to investing in IPOs as they would to any of their investments, which means understanding the business, asking if it has a strong competitive position in its sector, if the management is solid and if the asking price is fair.

If investors are happy with the answers to all those questions and they’re comfortable that the investment fits into their overall investment strategy and risk appetite, it’s an option worth considering.

How to buy shares in an IPO

Despite providing an opportunity for companies to widen their shareholder base and increase customer loyalty, IPOs definitely pose a challenge to retail investors such as you and me who want a piece of the flotation action.

AJ Bell reports that retail investors were invited to participate in just 7% of IPOs on the LSE in the three years to October 2020. As a result, investors are typically limited to trading once the shares are listed.

The firm said: “Unfortunately, too often, the advisers (to companies) recommend they just make the offer available to institutions, with no retail investor offering because it is seen as simpler, quicker and the way it’s always done.”

However, private investors may be able to subscribe to some IPOs through trading platforms that offer the REX service (provided by brokerage firm Peel Hunt) or PrimaryBid (an external service that facilitates IPOs).

Calendars of upcoming IPOs can be found on trading platforms and the London Stock Exchange, although these typically extend only a few weeks ahead.

What is the outlook for IPOs?

There’s been a dramatic slowdown in IPO activity after the record year in 2021. Global IPOs fell by 73% year-on-year in the first nine months of 2022, according to research provider Trading Platforms.

A similar trend was evident in the UK, with accountancy firm EY reporting that just 26 companies floated on the LSE in the first six months of this year, compared to nearly 50 in 2021.

Global stock markets have faced persistent macroeconomic and geo-political headwinds this year. High commodity prices and interest rate rises, along with the impact of high inflation on consumer spending, have created uncertainty around future cash flows for businesses looking to float.

As a result, IPOs are likely to remain on the backburner until there is a sustained upturn in global stock markets, and a fall in the current level of volatility.