Returns to style investments in initial public offerings

Security selection using style analysis is common practice among fund managers and individual investors. Style-based investments are not new, but their rationale derives from the perceived wisdom of practitioners and empirical evidence rather than from formal theoretical modeling. This chapter examines the aftermarket performance of initial public offering (IPO) by using style stock selection methods. It analyzes value, growth, small-cap, and large-cap style IPO portfolios, as well as combinations of these style categories. Holding period returns for value versus growth IPOs, small-cap versus large-cap IPOs, and IPOs marketed by high-quality underwriters versus those marketed by low-quality underwriters are compared. Several conclusions emerge from the comparison of returns of these style portfolios after controlling for risk. First, the value and growth IPOs do not exhibit statistically significant differences in returns for all holding periods. Second, the large-cap IPO portfolio outperforms the small-cap portfolio for up to 4-year holding periods. Third, IPOs sponsored by high-quality underwriters provide significantly higher returns than IPOs marketed by low-quality underwriters. However, after controlling for the quality of the underwriter, value and small-cap IPOs marketed by prestigious underwriters provide significantly higher and positive aftermarket returns.