The thesis is that the big, high profile "red hot" IPOs that are featured in the financial press, CNBC, CNN MoneyLine and The Nightly Business Report in the days and weeks before they start trading are generally poor investments for us individual investors who buy on the open market. What seems to happen to so many of these "red hot" IPOs is that the stock gets hyped up, thousands of people throw money at it on the first few days making it very expensive, the stock blasts up..and then eventually drifts down once the smoke has cleared. The press loves to talk about these things 'sizzling' on the first day. Yes they 'sizzle' if you are an insider or you get the IPO at the offering price. But they are more likely to 'suck' for the rest of us. Look at the charts for LNUX, FMKT, UPS, and and so on in their first few months of trading. There are some notable exceptions (RHAT, JNPR, SCMR) but I don't want to be the person betting my money that a red hot IPO will prove to be an exception.
So in general I'm saying it's not the red hot, heavily hyped up IPOs that we individual investors can make money on: it's the high quality IPOs that are overlooked or ignored when they come out. Because they are overlooked they may be available inexpensively on the open market in the first few days of trading, especially if a hot IPO is also coming out at round about the same time. I want to own these overlooked stocks so that I can benefit as they get discovered.
Recent examples of these overlooked IPOs are SWCM, KQIP, KEYN, IIJI, ITXC, IBAS, GRIC, RPCX, TRRA, USIX, and so on. These IPOs weren't featured prominently in the press or on CNBC before they came out. In some cases they weren't mentioned at all. Most of them have doubled...trebled...or even quadrupled. For example, look at KQIP. This high quality joint venture between the Dutch phone company KPN and Qwest Communications was almost completely absent from articles previewing that week's IPOs. And it came out on the same day as the huge UPS IPO, so all the attention was on that deal instead of KQIP...so it was easy to scoop up KQIP under $30 when it opened. After a few weeks it was an easy double. And since I sold it, it has gone on to make a new high.
In order to minimize risk I only really want to buy quality companies. This way if I get stuck with a stock that goes down, at least I know it has the potential to return to higher levels. So how do you know what constitutes a high quality IPO that may be overlooked when it starts trading.
I generally look for the following things:
- Minimal coverage of the company in the week leading up to the IPO. If it is on CNN and The Nightly Business report, or rated as Red Hot in www.redherring.com 's IPO preview, it will almost always be too expensive. You don't want to be competing with millions of people throwing money at the stock.
- See if there is a red hot IPO going out the same week that may capture all the attention, leaving your prospective purchase forlorn and overlooked.
- They have to be in a good, fashionable sector, such as Internet software, ASP, IP-based telecommunications services, business-to-business e-commerce, wireless, etc. I wouldn't get an Internet company specializing in content, or a web portal, or something offering some cool new product that is unproven. They must have lots of high profile customers and lots of high profile partnerships that will generate news.
- They have to be fairly unique and either own part or all of their market, or have few or preferably no publically traded pure-play competitors. Recent overlooked IPO software.com (SWCM) fitted both of these criteria They more or less own their market, and have no publically traded competitors that focus just on messaging software.
- They have to have existed for several years, so I am not buying something that has been thrown together quickly to cash in on the IPO frenzy. I look at the website to see if the management looks good. I like it if the founders of the company are still in charge, and prefer it if they haven't been put out to pasture to be replaced by someone bought in specially for the IPO.
- It's also important to look on their website and see if they are hiring a lot of people. This is a good sign of new business coming up and the explosive growth we are looking for. One recent IPO, DMRC, only had four vacancies, which was a really bad sign so I ignored that IPO. My local Taco Bell has more vacancies than that. I also check to see if they have a full calendar of trade show appearances. Using the website you can get a feel for if the company is for real.
- Look at the company's press release history on their website, or search a service such as newalert.com to see what the company has been up to. If a company's press releases show that they have been completing a contract every two months or so, that's a good indicator that this sort of action will continue, generating potentialy stock-moving press releases.
- Look at the company's financials in www.ipocentral.com or www.ipo.com. It doesn't need to be profitable, but it must have a rapid rate of revenue growth. Declining or stagnant quarterly revenues is a big black mark. Preferably we want explosive growth that;s already been sustained for several quarters.
- It's easy to search on forbes.com, news.com, zdnet.com and redherring.com to find out more about the company, especially to see if there is any analysis of the company.
- Look at the offering price and how many outstanding shares there are. That was you can calculate the market capitalization the company is beng offered at. Look at similar publically traded companies and see what market caps they have. This way you can get a rough guide of what market cap the company may possibly attain, and divide that by the outstanding shares to get a very rough target price.
I think it is important to decide what you are willing to pay for the stock before it starts trading. That way you won't get carried away. I only buy on the first day if something looks like a really good buying opportunity. A better strategy can be to wait a few days and see if it falls. Most of these overlooked IPOs have remained overlooked for several days or weeks after they start trading, so you don't necessarily have to own the stock you want on the first day. Many of them have fallen after the first few days, and actually provided better buying opportunities after the first day. SWCM and USIX are both examples of this. Study some of the charts to figure out how these things move. It is dangerous to place market orders for IPOs on the first day because you may get stuck with a high price and then watch the stock fall. I prefer to see what price it opens at and then make my decision. This way, you can see whether you were right about it being overlooked before you commit your hard earned cash. If I buy on the first day I would still use a limit order because the stock may move significantly in the time between your order being placed and being executed.
If in doubt, stay out. |
