Do Software IPOs Beat the Market?

by Christian Chabot on September 24, 2009

Technology IPOs have seen days of glory and annihilation. Small wonder they evoke strong opinions. Warren Buffet said of IPOs, “It is almost mathematically impossible, that, out of thousands of goods and services available everyday to consumers, the most attractively priced would be the one sold by an educated seller to a less educated buyer.” Others claim that the IPO shortage is a crisis holding back economic recovery.

Has anyone asked the simple question: Are technology IPOs a better investment than the market? Are technology IPOs more attractive than investing in a broad market index? If they can’t beat this basic economic hurdle, it would seem their prospects are dim.

We decided to look at the data. The result is surprising.

We examined a large sample of software companies that went public between 1969 and 2008. We compared the performance of each stock to the performance of the Nasdaq during the period after each IPO.

Top IPOs Beat the Market

First some good news: The average software IPO in the sample beat the Nasdaq by 52% after one year and 94% after two years (upper visualization). Impressive performance compared to most other investment options. Long live the IPO.

But don’t get too excited.

The sample the finding is based on consists of today’s top 100 publically traded software companies. These companies are, by definition, successful companies. We would expect them to have done well. Now we know just how much more successful they have been.

Invest in IPOs? Flip a Coin.

But here is the surprise finding from the study: Nearly half (46%) of the IPOs underperformed the Nasdaq during their first year as a public company. The large variance in the sample is shown in the lower visualization (red/green). Forty-six percent of those lines are red, meaning they underperformed the Nasdaq in year one. The situation improved a little by year two, at which time 40% had underperformed the Nasdaq.

This is a surprising result considering the sample: All of these companies ultimately ranked among today’s top 100 software companies. And yet buying the Nasdaq index, at least initially, would have been a more fruitful investment nearly half the time.

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Dan Murray September 24, 2009 at 5:36 pm

Tableau Public is pretty slick. I filtered and then exported my view to pdf, just like you can in the Desktop, Reader and Server products.

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