Initial public offerings generally reside at the riskiest edges of the stock market, an unavoidable cost of being new. But in an environment in which every stock — from the freshest venture to the most venerable blue chip — seems remarkably risky, how do these new issues fare?

The dream for investors is grabbing a slice of a hot IPO at the issue price and flipping it for large profits as the pent-up demand drives the stock higher once it hits the market. That dream was realized by many investors while the technology bubble swelled, as demand for the “next big thing” far outstripped the supply of worthy tech stocks coming to market. But the reality of IPO aftermarket performance is often much less rewarding.

Although there is the odd company that comes to market and sees its stock take off, more often than not these new, untested companies disappoint after going public. In past years, Investment Executive research has found that, overall, IPOs tend to underperform the market in the period following their début.

On balance, IPOs often aren’t worth the risk. The few big winners that may lurk in each crop of new issues are not sufficient to outweigh the majority that underperform the market. And, without a foolproof way to separate the winners from the losers ahead of time, buying new issues is typically a dicey bet.

At least that was the situation in the bull market. In hot IPO markets, underwriters will typically push out every sort of deal they can get their hands on before the window for new issues closes. From the investor’s point of view, this kind of seemingly indiscriminate deal making can make it even harder to separate the wheat from the chaff.

Yet, markets have been far from bullish over the past year — and the Canadian IPO market could scarcely have been any colder as a result. So, in an environment in which very few companies are able to come to market, can those that are confident enough to launch an IPO actually outperform? Can wretched markets serve as an effective screen for good IPO companies?

IE’s research shows that this is probably not the case. In fact, the new companies that came to market in 2008 fared somewhat worse than did the market overall during this tumultuous period. The average IPO on the Toronto Stock Exchange last year fell about 47% from its issue price to Oct. 1, 2008. By comparison, the S&P/TSX composite index slipped 18.4% from June 30 to Oct. 31 (there were essentially no new deals after June 30).

After Oct. 1, markets got even uglier, with the TSX index ending down 37.4% from June 30 to the end of the year. Again, the year’s IPOs performed even worse, finishing on average 67% below their issue price to Dec. 31. On a dollar-weighted basis, more than half of the capital raised in the first half of the year via IPOs was wiped out by the end of the year — about $500 million worth.

At the start of October, a couple of 2008’s IPOs were still in positive territory. However, by the end of the year, every stock was down from its issue price, with the best performer down by 26% (outpacing the index, if nothing else), and the worst names having almost gone to zero.

That said, the news was considerably better in the junior market. At the end of the year, 40% of the IPOs and capital pool companies on the venture exchange were either higher or unchanged. On average, these issues recorded a negative return of just 4.6%. Not only is this far better than the average return for the stocks that débuted on the senior market, but it also far outstrips the 70% decline suffered by the S&P/TSX venture composite index from June 30 to Dec. 31.

However, the simple average is distorted by the fact that many of these offerings débuted with initial prices of just a few cents a share, so even a relatively modest price gain translates into a large percentage gain.

Looking at these returns from other vantage points, the returns for these venture deals aren’t nearly as impressive. The median return from issue date to the end of the year was a 36% loss; and, on a dollar-weighted basis, over 55% of the capital raised in these deals during the year had evaporated by the end of the year. So, while the venture market certainly offered the possibility of hitting a winner last year, it was also a fairly tough audience for new companies.

@page_break@At the best of times, IPOs can be a dodgy proposition, and last year was no exception. While extreme volatility may have kept most young companies from testing the public waters, those that did generally got a rough ride for their trouble. IE