Equity, as a source of funding, is a lot more expensive than debt. With debt your cost is the interest. With equity, your cost of capital is a portion of all future earnings of the business. Logically, a company should only want to sell equity, or IPO, when the price they can receive is over and above the intrinsic value of the business.
This can be seen in the long-run performance of IPOs. Professor Jay R. Ritter, of University of Florida, has kept a data set of IPO performance. It’s clear that retail investors, buying on the opening day, severely underperformance the broader market over the long term.
The nuanced take, though, is that some businesses do outperform in the long term. In my personal opinion, it would be biased an unintelligent to completely write off all IPOs, as Graham suggests, because great businesses IPO too. You should just be skeptical, and approach it in the same way that you approach any other business. Understanding the fundamentals, the long term economic prospects, and buying when there is a margin of safety. That might mean buying on opening day, or it might mean waiting years for the price to come down to something more reasonable.
Connections
The Cost Of Underperformance Is Worse Than Just Losing Money
Link Explanation: If the cost of underperformance is worse than losing money (losing opportunity cost returns, and time), investors should be extra skeptical of IPOs which have misaligned incentives to public market participants and a track record of market underperformance.
Prices Reflect Perception, Not Truth
Link Explanation: No where is above note more relevant than in an IPO. At this moment, it is likely that the business will be under the biggest spotlight of its life, the bankers issuing the stock have a duty to their clients to get the right price, and the stories and narratives around the business will be the most convincing. An investor would do well to remember the note linked above before investigating an IPO company.
Reference
Prof. Ritter: https://site.warrington.ufl.edu/ritter/published-articles/