"Don't believe hype". The saying is known from Public Enemy, but
in reality could fit for investor considering buying in an IPO. At
Report, Louis Basenese even says that that's the "perfect
motto" in the IPO market. The article exploits recent tricks which
investors can fall, including the ones that happened with tech
companies like Facebook or Groupon.
I've spilled considerable ink trashing a handful of upcoming
initial public offerings (IPOs). The most notable ones being daily
deals company, Groupon, and social networking
juggernaut, Facebook. In fairness, though, the
fundamentals warrant it.
However, while Wall Street and the media like nothing more than to
jump on the latest hot stock market offering and whip the masses
into a frenzy, not all IPOs are created equal. There's plenty of
money up for grabs from this market. But to do it, you must
follow two rules:
Rule #1: Don't Believe the Hype:
I've found that the most hyped IPOs tend to be terrible
investments. Why? Because prices run up too far, too fast, before
everyday investors have a chance to buy shares. Sadly, the only
ones able to book profits are insiders - hedge funds, mutual funds
and ultra-high net worth investors - that were fortunate enough to
get an initial allocation.
But all hope isn't lost. IPO riches are attainable. Which brings
me to Rule #2...
Rule #2: Know the Signs That Indicate An IPO Has Investment
Once we shun the overhyped deals, we can instead focus on
fundamentally sound, fast-growing, under-the-radar IPOs.
That's what I'll show you in this article: How to separate the IPO
contenders from the pretenders.
"More millionaires have been made in the IPO market than in any
other segment of the stock market." So says financial author, David
That's undoubtedly true if you look at the first-day IPO gains
that some companies have enjoyed. For example...
- Online travel company, Priceline.com (NASDAQ:
PCLN), blasted 331% higher on its March 31, 1999 stock market
- Chinese internet search company, Baidu, Inc.
(NASDAQ: BIDu), rocketed by 354% on its first day of trading on
August 4, 2005.
- Chipotle Mexican Grill (NYSE: CMG) notched a
100% first-day gain on January 25, 2006.
- More recently, the heavily hyped business networking firm,
LinkedIn (NYSE: LNKD), bounced by 109% when it
launched on May 19, 2011.
Stellar gains, for sure.
That being said, many investors are hesitant to invest in the IPO
market today. Here's why they're missing out - and how you can
claim your share of the outstanding profits on from this
The IPO Market: Like Ibuprofen for Economic Pain
The current doom-and-gloom over high unemployment, the perpetually
depressed housing market and a stagnant overall economy has created
furious stock market volatility. As a result, both would-be IPO
companies and investors have backed away from the IPO market.
But know this: The IPO market is one of the best places to invest
following a recession. And the profit potential increases if the
slump is prolonged, like we're experiencing today.
Take the recession of 1973 to 1975, for example. Like today, the
period also featured high unemployment and war. But as the United
States emerged from it, the IPO market heated up. From 1975 to
1979, IPO stocks returned an average 34% gain per year for
investors - four times better than the Dow's performance.
The truth is, companies with viable, sustainable business models
not only enjoyed strong stock market debuts, they've also stood the
test of time and have prospered ever since.
For example, athenahealth, Inc. (NASDAQ: ATHN)
posted a 97% return on its first day of trading and now sits some
261% higher than its original offer price of $18. And Under
Armour, Inc. (NYSE: UA) was originally offered at $13 and
notched a 95% first-day gain. It now trades around $70 - 438%
higher than its IPO price.
This debunks a common misconception among investors: That IPO
gains are only reserved for a privileged few preferred investors
(company executives, hedge funds and institutions). It's not
So how do you profit from IPOs?
Let's run down a few key characteristics of a strong IPO...
The Top Four Ways to Spot A Hot IPO
- Long-Term Growth Potential: When you invest in an IPO,
you're investing in the future growth of that company. So it stands
to reason that if you jump on a company in the early stages of a
significant, long-term growth cycle, you can scoop handsome profits
before the crowd catches on. Go for companies in markets that offer
10 years of growth potential.
- Two Years of Profitability: Remember the old stock
market adage: Share prices follow earnings. Most IPOs that fail
after their stock market launch do so because they lack earnings.
But if a company is growing the bottom line, the share price is
likely to follow. Roughly 75% of IPOs during the dot-com days
couldn't make the "profitability" claim... and they ended up on the
So insist on at least one to two years of profitable operations
and you're more likely to avoid stepping on an IPO landmine.
- $50 Million-Plus in Annual Revenue: Just as share
prices follow earnings, they also follow revenue, according to
University of Florida research. The key question is whether a
company had sales of $50 million in the year prior to going public.
Those that did rose by an average of almost 40% over the following
three years. The companies that weren't above the $50 million
threshold only posted a 5% return over the same period.
- Age: Make sure a company has existed long enough and
has demonstrated its long-term viability by the time it hits the
stock market. Why? Because the older and more established a company
is when it goes public, the better its shares tend to perform. Such
proven viability isn't something you could say about most IPOs
during the dot-com collapse. The average IPO back then hit the
market at just four to five years of age.
Essentially, when you're investing in IPOs, follow the same rules
as you would for other stocks. Namely, that fundamentals ultimately
drive share prices. So use the guidelines above. The stronger the
fundamentals, the greater the profit potential.
In addition, look for companies that intend to use IPO money for
upgrading or expanding the business, rather than just lining the
pockets of the executives and preferred investors. This helps
filter out the overly hyped, more speculative offerings and,
instead, places the focus on robust, long-term fundamentals.