New Issues Puzzle

Project 5 — New Issues Puzzle

(i). I gathered my information on recent IPO activity from the NASDAQ website. While selecting the new issues to short, I concentrated on incorporating the small growth puzzle. The small growth puzzle shows evidence that the majority of new issues come from small growth firms. A popular argument is that small growth firms are known to underperform, which explains why new issues are dominated by them. Many support the idea that the new issues puzzle and the small growth anomaly represent a single anomaly that presents itself in two different ways. Once I gathered the names of the companies that had recently issued equity, I focused on selecting from among them the ones that most clearly represented characteristics of being a small growth firm. I gathered data and chose the stocks with low market caps and high price-to-earnings ratios.

A factor based on real investment, known as the investment-to-assets ratio, could also be beneficial in helping me make my selections. Prior studies have shown that small growth firms have higher investment-to-assets ratios than others, and these firms also represent the most frequent equity issuers. Since issuers are known to have the highest investment-to-assets ratios, it clearly indicates how real investment can be a driving force behind the new issues puzzle. While it is difficult to obtain the necessary information, I could determine the investment-to-assets ratio by finding the annual change in property, plant, and equipment, add it to the annual change in inventories, and then divide by the book value of assets for each individual stock. I would likely find that recent issuers have higher investment-to-assets ratios and lower expected returns than matching non issuers. To earn a profit I would short the firms with the highest investment-to-assets ratios and purchase the ones with the lowest investment-to-assets ratios.

Retrieving information on the turnover levels of recent IPO’s could also...