February 2025, From the Field -
The gradual recovery in U.S. initial public offerings (IPOs) that began two years ago could gain momentum in 2025.
What’s exciting about this prospect is the chance to invest in growing companies when they aren’t well understood by the market or represented in the indexes that underpin many passive funds.
The value of new U.S. stock listings has only ticked up modestly from 2022, when rapidly rising interest rates and COVID-related distortions in some industries depressed IPO activity (Figure 1).
As of December 31, 2024. Source: Bloomberg Finance L.P.
But many of the headwinds to IPO activity have diminished, likely creating a supportive backdrop for IPOs.
At the same time, the private equity (PE) industry is keen to monetize a large backlog of unsold assets after the challenging environment constrained IPOs and mergers and acquisitions (M&A).1
These dynamics, combined with optimistic comments from investment banks and publicly traded PE firms, suggest that IPO-ready companies could be preparing to go public if market and economic conditions remain accommodative.
Performance quoted represents past performance, which is not a guarantee or a reliableindicator of future results.
December 31, 1985, to December 31, 2024.
Source: T. Rowe Price calculations using data from Compustat and FactSet Research Systems Inc.All rights reserved. See Additional Disclosures.
1 ROIC is the median return on invested capital for all the constituents of the Russell 2000 Index andthe Russell Midcap Index at the end of each month. The graph depicts the average of these monthlymedian ROIC observations.
Historically, many IPOs have landed in the micro- to mid-cap range.
However, the quality of businesses further up the capitalization ladder tends to be higher (Figure 2).
Part of this divergence likely stems from the maturity of mid-cap companies relative to the emerging growth businesses in the small-cap universe and the benefits that accrue to businesses with scale.
Adverse selection has been another factor. Companies increasingly have opted to stay private for longer, tapping a deep pool of available capital and avoiding the regulatory burdens and market volatility that publicly traded companies face. In other words, more and more businesses are skipping the small-cap phase in their lives as public companies.
This year’s IPO class is likely to involve more high-quality companies than the 2021 rush to go public. The businesses that investment bankers and sponsors choose to bring public in a recovery cycle’s early stages tend to be more established to help keep the IPO window open.
In some instances, IPOs can present an opportunity to invest in quality companies when they are not as well known.
These structural inefficiencies can create opportunities for firms that have built robust internal research capabilities spanning industries, asset classes, and public and private markets.
Still, investing in an IPO involves unique risks because these companies lack a public track record. Selectivity is critical.
Large active managers may be able to give their clients exposure to IPOs that they might not otherwise be able to access.
They can also support a global team of experienced research analysts to offer both breadth of coverage and depth of knowledge.
When analysts have the time and resources to go beyond the numbers and develop a deep understanding of the competitive dynamics in their coverage universe, they may have a better ability to assess the longer-term risk/reward profile of companies that are going public.
Relationships built over the years with private companies and collaboration with fixed income analysts can also provide a relative advantage.
Here are some of the considerations that are front of mind when considering whether to participate in a company’s IPO and potentially build a larger position over time.
Dante Pearson is the associate portfolio manager for the US Structured Active Mid-Cap Growth Strategy in the Global Equity Division. He is an Investment Advisory Committee member of the US All-Cap Opportunities Equity, US Structured Active Mid-Cap Growth, Small-Cap Growth Equity, and US Real Estate Equity Strategies. He is a vice president of T. Rowe Price Group, Inc.
1 I explored the M&A slowdown of recent years, the drivers of a likely reacceleration in dealmaking, and the potential risks and opportunities for investors in my July 2024 article, “M&A Revival Means Management Quality Matters Even More.”
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