Initial public offerings are back with a vengeance…or so it seems. This year alone we’ve seen 64 companies go public, raising a combined total of $16.8 billion. That means that U.S. IPOs are on track to have their busiest year since before the financial crisis. In the past few months, we’ve seen several new faces on Wall Street, including Seaworld Entertainment Inc. (SEAS) and Duncan Hines’ owner Pinnacle Foods Inc. (PF). And just last month, the insurance unit of Banco de Brasil–BB Seguridade–raised $4.25 billion, making it the largest IPO this year so far.
So far, a lot of these big names have performed decently since their launch date–SEAS is up 11% while PF is up 14%. So now that it has been a full year since the volatile Facebook (FB) IPO, have IPOs finally found their stride?
Not necessarily. While investors may be more risk-tolerant of late, I believe this will disappear at the slightest hint of market choppiness. As a general rule, I recommend 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 last year. And Groupon Inc. (GRPN). And Zynga Inc. (ZNGA). In fact, these three stocks are down a whopping 31%, 73% and 65% since their IPOs.
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.
So I don’t recommend that you buy into the IPO hype. 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’re seeing now, 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.
Until next time,