Year 2005 | Volume 12    Southern Methodist University

        Paul Krueger
        Willard Spiegelman
        David Son
        Virginia Dupuy
        Alan Brown
        Wayne Shaw
        Evelyn Parker
        Valerie F. Hunt
        Dan Orlovsky


Taking Stock

How can the average investor take advantage of market data that only brokerage firms can afford to access? Wayne Shaw has an answer: Watch how the big teams play on opening day. Five years ago he wrote a paper demonstrating that on the first day of an initial public offering (IPO) he could separate firms by performance simply by tracking the first trade by an institution.

“Institutions have the money to collect information the rest of us don’t have,” says Shaw, the Helmut Sohmen Distinguished Professor of Corporate Governance in the Cox School of Business. “If they immediately sell a stock after it goes public, they’re telling you there’s something they don’t like about it. If they buy more, they’re showing that they do like it.”

Now Shaw has taken that research to the next level: He has developed a mathematical win/loss model for IPOs that can separate the diamonds from the dogs even before the stock comes to the floor.

Originally, Shaw set out to build a model that would predict which firms would withdraw from the IPO process. He found that if the model predicts a company such as Texas Roadhouse – to use a real-life example – should not have gone public, its stocks consistently underperform the market. The model can pick the winners, too: Stocks it identifies as ripe for public offering, such as New River Pharmaceuticals, consistently perform at market levels.

Shaw’s model is based entirely on publicly available data that includes the size of the offer, revenues and debt, initial price range, and whether the price was changed upward or downward. “It’s all information that everyone is required to disclose as part of the process,” he says. And the model, applied to 3,941 IPOs filed from 1995 to 2001, “worked exactly the same way each year in which we’ve tested it.”

Keeping an eye on these factors can help individual investors avoid an IPO wasteland, Shaw says. “Many of these firms are not very healthy. People are trying to cash out, and some of them are misstating a company’s future possibilities to get the highest price they can. The more you can observe from history, the better off you are.”

Shaw, who received his Ph.D. degree in financial accounting from the University of Texas at Austin, joined SMU in 2003. He has worked with the Internal Revenue Service, taught at Cornell and the University of Colorado, and served as an expert witness for the Securities and Exchange Commission and various law firms.

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