The Secret To Making 94% Gains on the IPO Market

Congress may be at the eleventh hour to get a debt deal passed, but Wall Street breathed easier today as the Dow and S&P 500 closed up over 1.3% today. With investors cautiously optimistic that tomorrow will bring a resolution to the mess in Washington, they’re refocusing on all that has been going on outside of the beltway. In addition to earnings season kicking into high gear, the other main focus is the resurgence in initial public offerings (IPO).

And of course at the top of everyone’s radar is Twitter, which is expected to begin trading as “TWTR” on November 15. If Twitter’s underwriters are satisfied with the demand for the stock, the IPO launch date could get bumped up to a week earlier—November 8. While we won’t get an official price until the day before the launch date, analysts are pegging Twitter’s value as high as $15 billion. This is pretty impressive, considering that the company has yet to post a quarterly profit.

Provide all goes according to plan, Twitter will be joining a flurry of other recently priced IPOs, including popular off-price retailer Burlington Stores Inc. (BURL), sandwich chain Potbelly Corp. (PBPB) and real estate broker RE/MAX Holdings Inc. (RMAX).

The tech sector has been particularly hot lately, with recent public debuts from malware protection software developer FireEye (FEYE), artificial intelligence expert Rocket Fuel (FUEL) and benefits software maker BenefitFocus (BNFT).

And there’s plenty more where that came from—these companies are also on deck to go public:

  • Chrysler—the Big 3 Automaker is looking to regain control operations from Italian automaker Fiat, which currently owns a majority stake in Chrysler. Fiat is looking to buy the remaining shares in Chrysler, so this IPO is an effort to stave off a complete takeover.
  • Hilton Worldwide Holdings Inc.—the global hospitality chain filed to raise $1.25 billion. Analysts estimate that the stock market could value the deal at $30 billion.

But as I covered a last month, good things come to those who wait. I make it a rule to wait until a stock has “proven” itself on Wall Street before recommending it for new money.

There are several reasons for this. For starters, 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.

Case in point is Facebook Inc. (FB)—what was undoubtedly the hottest IPO of 2012. On May 18, 2012, scores of investors reacted to the hype and added shares of FB around $38 per share. By the end of the week, the price plunged over 16%. By the end of two months, the stock lost half its value.

And then there’s no telling how the company is doing financially—not until the next earnings season, at least. So I like to see at least four quarters’ worth of data before I assess if it has the growth needed to be a successful investment.

Once again, FB is a great example of this. When I first added FB to my Portfolio Grader screening tool last May, we finally had four quarters’ worth of data. And the financial picture wasn’t pretty. The company was struggling to grow earnings operating margin growth was nonexistent. The company had a history of missing earnings estimates, and its return on equity and cash flow weren’t anything to write home about. All the while, institutional investors all but gave up on FB, so buying pressure had dried up. So I was compelled to rate FB as a D.

Sure enough, the stock continued to flounder until July. Then it all changed with the company’s second-quarter earnings announcement. The company’s drive to be more mobile friendly finally paid off as Facebook’s mobile business accounted for 41% of its advertising revenue that quarter. Compared with Q2 2012, revenues jumped 53% to $1.81 billion. This trounced the $1.62 billion consensus estimate. Meanwhile the company saw adjusted earnings of $0.19 per share, beating the $0.14 consensus earnings estimate by nearly 36%.

At that time, my screens detected a pickup in buying pressure and improving fundamentals, so I upgraded FB to a B-rating within a week. And what would you know? The Facebook rally continued…so much so that the stock has soared 94% since that fateful earnings announcement!

So you see, when it comes to IPOs, it’s all about the timing. And in my experience, rarely should you buy a stock when it first flies out of the gate. That’s a great way to get caught chasing a stock, only to have it plunge once the initial hype dies down. Instead, I recommend you wait for at least four quarters’ worth of earnings data and then make a rational decision on whether the stock has what it takes for your money. As always, my Portfolio Grader tool is available to help you make an informed choice.

Louis Navellier

Louis Navellier

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