How to Play the Red-Hot IPO Market

How to Play the Red-Hot IPO Market

The market just closed out its best first quarter in 14 years, and companies are realizing that if ever there were a time to go public, this is it.

That’s why the Initial Public Offering (IPO) market has been red-hot. The volume of IPOs is at the highest level since 2007, with $5.8 billion raised from a total of 44 new offerings. And there are an additional 157 companies that have announced their intent to go public but haven’t yet announced pricing. That could be another $33 billion in offerings in the making–and all of this profit potential could be a great way to get investors excited about stocks.

And that’s the real key to playing this trend–profiting from the excitement IPOs generate, but not necessarily from the IPO itself.

IPOs are a great thing for the market. They get folks excited about stocks and may serve as a rising tide that "lifts all boats" in the sector. However, when it comes to investing in IPOs, the little guy usually gets the short end of the stick.

These deals are structured so that insiders and backers get the best price, and then they tend to dump shares on the market while everyone else is trying to get in. That’s why you tend to see share prices fall off a cliff shortly after the IPO.

Just look at the recent chart of Groupon Inc. (GRPN), and you’ll see what I mean. GRPN started trading on November 4, 2011. Shares closed that first day at $26.11. But, just 15 trading days later, shares were going for $15.24–a 41% haircut for the little guy.

And then there’s Pandora Media (P). Shares on day one were $17.42, but just three months later, the stock was hovering around $10–a level it still struggles with today.

Don’t forget Renren Inc. (RENN). May 2011 was an exciting time for the company, and shares hit a high of $24 on the first day of trading. Unfortunately, that was as good as it got for the social networking company as shares have dropped continuously since and are going for less than $5.50 apiece today.

The list goes on and on, and this is why I don’t recommend buying IPOs. There’s too much volatility early on, and unless you’re like Warren Buffett and can get a sweet deal on these offerings, you’re probably going to get hosed.

If you want to get into these companies, I recommend that you come back in a year or two and then consider adding these companies. And I say that for one specific reasonearnings results.

A company needs at least four quarters’ worth of data before you can really assess if it has the growth needed to be a successful investment. And that’s what’s really hot right now–especially given that earnings season kicks off in just one week.

After any major market rally, like the one we saw in the first quarter, investors take profits off the table and move them into the companies they see as the next winners. And because no one wants to lose their winnings, they put that money in safer investments. This is called a “flight to quality.” Investors want to go with established companies with solid fundamentals that they can trust.

This why now is such a compelling time to be a growth investor who focuses on fundamentals.

If you’ve followed me for any length of time, you know that I follow eight key metrics that have been proven to determine the financial health of a company. I watch sales growth, operating margin growth, earnings growth, earnings momentum, earnings surprises, analyst earnings revisions, cash flow and return on equity. If your investments get passing grades in these eight areas, you can sleep easy.

I urge you to run all of your stocks through my ratings tool to see how they stack up. And you can do it for free at

To get you started, go to Portfolio Grader and type in the tickers for Apple Inc. (AAPL), Baidu Inc. (BIDU) and Hewlett-Packard Co. (HPQ). You’ll find two stocks to buy and one to sell, but you’ll have to see for yourself which is which.

In this market, it pays to stick with stocks that have a good track record. There are plenty of existing players with tremendous upside, so for now I say profit from the excitement surrounding IPOs, but wait a while before dipping your toes into the latest wave.

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