Goldman Sachs unveils 2 simple IPO-investment strategies that have crushed the market over the past 25 years
- David Kostin, the chief US equity strategist at Goldman Sachs, identifies two IPO strategies that have outperformed the market by 60 and 280 basis-points, respectively, since 1995.
- At the center of these strategies are equal-sized investments and the practice of cutting losers as soon as possible.
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When a company first trades on a public exchange, the majority of investors fall into two distinct categories: staunch believers and non-believers.
They either think the stock is going to the moon, or it's going bust. There's generally not an excess of opinions in between.
But it's inherently difficult to discern which companies will be successful in the early stages, regardless of private-market hype. After all, the amount of data that investors have to work with is paltry at best. This leaves even the most skilled prognosticators making guesses and assumptions.
Amid all of that uncertainty, how can an investor avoid getting steamrolled while still getting a piece of what could be the next stock-market darling?
That's where Goldman Sachs chief US equity strategist David Kostin comes in. He's identified two simple approaches to conquer the IPO market over a prolonged period.
Kostin's approach isn't flashy by any means. It ultimately boils down to casting the widest possible net and implementing a disciplined, consistent strategy.
Here are his best strategies for investors looking for outsize returns from newly public companies:
(1) Invest an equal amount in every single newly public company
To Kostin, there's no need to take a long shot on a single company. The move in itself is extremely risky, and chances of success are low, especially since it's such a crapshoot which stocks will explode higher.
He instead recommends investing an equal amount every single IPO that hits the market. It's a strategy Kostin says outperformed the Russell 3000 by 60 basis points, on an annualized basis, since 1995. All an investor had to do is buy and hold.
"Most IPOs underperform, but some new offerings outperform dramatically," he said in a client note. "From a performance perspective, those 'winners' have the ability to drive portfolio outperformance even as the median IPO lags the market."
To demonstrate his point, Kostin provides the following chart:
"For instance, a portfolio that invested $100 in the Amazon IPO in 1997 would have outperformed the Russell 3000 through August 2019 even if it also made $100 investments in 160 IPOs that subsequently went bankrupt," Kostin said.
But Kostin's analysis doesn't stop there. He's discovered another, more dynamic strategy that generates even larger returns:
(2) Buy every single new IPO offering with the proceeds gained from selling the worst-performing recent IPOs
"On each IPO date, our 200-position portfolio invests in every new IPO at the end of its first day of trading and funds those purchases with the sale of an equal number of existing holdings with the lowest trailing 3-month performance," he said.
Kostin finds that this strategy has outperformed the Russell 3000 by 2.8% on an annualized basis since 1995.
It's ultimately congruent with an age-old adage on Wall Street: cut your losses as quickly as possible. In doing so, investors can live to fight another day. Remember, a 50% loss requires a subsequent 100% gain to get back to even.
In order to implement this type of approach into your portfolio, Kostin recommends allocating an equal investment figure on the day of addition, and avoiding a rebalance. This methodology lets winners keep running, and doesn't allow overzealousness or pessimism skew new trades.
Here's a chart Kostin offers to support his findings: