Don't Get Burned By IPOs

Initial public offerings came back from their long slumber this year and last with hot offerings like online coupon site Groupon (GRPN), Internet radio company Pandora (P), Chinese social network RenRen (RENN) and social game developer Zynga (ZNGA).

And of course, the grand-daddy of them all: Facebook (FB).

But performance has been bumpy, to say the least, and that’s not much of a surprise. I recommended staying away from all of these IPOs when they first started lighting up the headlines, because the little guy usually finds himself on the short end of the stick when it comes to IPOs.

Far too often, these deals are structured so that insiders and backers get the best price, and then they tend to dump shares on the market after the "lock-up" period expires. That’s why you tend to see share prices fall off a cliff a few months after the IPO.

Hint: That’s exactly what we’ve seen with Facebook. And Groupon. And Zynga. In fact, these three stocks are down a whopping 45%, 82% and 70% since their IPOs.

And the Trulia (TRLA) IPO just last week initially got off to a great start—surging more than 40% to finish near $24, sharply higher than its initial pricing at $17. Since that first day, however, shares have started to meander downward, likely driven by questions about the business plan of its competitor Zillow (Z), which until a few days ago was one of the brightest spots in the IPO field from the last year or so.

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 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 reason—earnings 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 two weeks.

After any major market rally like what we saw over the summer, investors take profits off the table and move them into the fundamentally strong companies they see as the next winners. 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 PortfolioGrader.com.

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

Until next time,

Louis Navellier

Louis Navellier

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