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IPOs for Financial Fashionistas

Tracy Byrnes

If gold can become a fashionable investment again, then there's hope for anything -- including the IPO market.

And while gold lame may bring back fond (ha ha) memories of the 1980s, the mere mention of the term IPO whisks us right back to the roller-coaster ride of the late 1990s.

But things are different this time around. For starters, the only wearable metallic item I will purchase this fall will be a belt. Fortunately for all of us, the current IPO market is showing similar good taste.

Aside from Baidu.com's (BIDU - Cramer's Take - Stockpickr) 239% first-day pop on Aug. 5, the average IPO is climbing around 11% on the first day, according to IPOhome.com. "So it's a much more rational place to be right now," says Kathy Smith, principal at Renaissance Capital.

Clearly, we're not seeing an endless stream of profitless dot-coms going public. More seemingly stable sectors, such as health care and energy, are doing more of the offerings -- and doing quite well too. Of the 23 health care IPOs thus far this year, the average return has been around 15%, according to IPOhome.com. And the energy sector's 10 IPOs have averaged a whopping 24% return.

For example, Threshold Pharmaceuticals , a biotech firm that develops metabolism-based therapeutics for treating tumors, is up about 42% since its Feb. 4 offer date.

Winners in other sectors include Verifone , a global provider of electronic payment point-of-sale systems, which is up 85% from its April 29 IPO.

But for the most part, the pace is not frenetic, and most of these companies actually have earnings even before they hit the exchanges. Does that mean you should be investigating IPOs for your portfolio?

If you can get your hands on the right information, there can be a place for them. But IPOs can be very risky. So let's go through the mechanics of a new offering and then help you determine if these are the right stocks for your portfolio.

Whether these companies need more working capital, want money for acquisitions or have to pay down some debt, more financing is generally the driving factor behind an initial public offering, says Todd Huxster, electronic data editor for IPO Vital Signs.com.

So investment bankers such as, say, Goldman Sachs, Morgan Stanley or Lehman Brothers are hired. Then attorneys are brought in and a registration statement is filed with the Securities and Exchange Commission. About 30 days later, the SEC will respond to the statement with questions that must be answered before the company can go public.

Then the bankers hit the streets and try to promote the stock to potential investors; this traveling PR party has been dubbed the "road show."

Keep in mind, you and I have a better shot at getting into Madonna's 47th birthday party than attending a road show. The typical guest list is made up of institutional investors and others willing (and able) to buy big chunks of the stock.

Once the bankers, a.k.a. the underwriters, think they have enough interest to sell the stock, they attempt to set a reasonable price based on level of interest, says Alan Paley, co-chair of Debevoise & Plimpton's securities practice group in Manhattan. When the company agrees to the suggested pricing, an underwriting agreement is signed, a final prospectus is created for potential investors, and then it's off to the races -- or at least the offerings.

Now you could just wait until the stock is available on the open market and invest at that point. But here's the rub. The stock could jump on the first day of trading, so it would be nice if you could take advantage of that bounce. Baidu.com, the so-called Chinese Google , for example, is up 218% since its IPO. But if didn't buy (early) on the first day of trading, you're probably sitting on a losing position right now.

But getting IPO shares is tough. They are generally reserved for the people in the inside.

Reservations, Please

So how do you get in on this?

Well, in many instances, you don't. But stranger things have happened, and ingenuity, hard work and (yes) good luck can help get your hands on some shares.

First, you need to decide if you even want the stock. Do some research on sites such as Hoovers.com or IPOhome.com and educate yourself on the company and its competitors. Then read the prospectus of the IPO you've selected and determine what the company plans to do with its new financing. Is it simply going public to pay off some debt? Or is it using the money to reinvest in the company and help it grow?

"Use of proceeds is a good indicator for whether want or not you want to invest in the company," says Huxster.

Then go through the audited financial information carefully. But since you won't have much of it available, IPOs should clearly be considered in the aggressive part of your overall portfolio, says Bob O'Hara, VP of development at BetterInvesting. But as long as you can get good information, you can make a sound decision.

Once you find an IPO that you like, the easiest way to get those shares is to have an account with the bankers working on the deal. So if you're working with, say, Morgan Stanley, and its underwriting an IPO, your broker may be able to get you some shares.

But your broker might not know about the deals going on in his firm, so check the company's Web site to see what they're working on, suggests Smith. And be sure to mention them to your broker and ask him to get you in on it.

If after you've investigated an upcoming IPO you realize you don't have an account with the corresponding banker, try opening one before opening day. If you offer up enough money, you may still be able to get a piece of the deal.

And don't dismiss the online brokers. Their share-allocation system is less tied to your bankroll. Some firms will give you shares because you trade frequently or because your trading activity is profitable. So be sure to check out the IPO rules at the online brokers.

If that doesn't work, try the fund world. For direct exposure, you can try Renaissance Capital's (IPOSX - Cramer's Take - Stockpickr)IPO Plus Aftermarket fund, which is up about 5% this year. It focuses solely on IPOs, so it's meant to be small percentage of a well-diversified portfolio, says Smith.

Other funds focus more on the small-cap world, which is where many IPOs germinate. The (ASCGX - Cramer's Take - Stockpickr) Adams Harkness Small Cap Growth fund, run by veteran Mary Lisanti, has been around for only about 18 months but is up 7% for the year. And check out the ( KAUFX - Cramer's Take - Stockpickr) Federated Kaufmann fund. It too focuses on small-cap offerings, is up about 5% for the year and gets four stars from Morningstar.

IPOs are back in vogue, so in an effort to stay ahead of the trends, be sure to add something metallic to your wardrobe this fall and keep the IPO world on your radar screen.