You get asked a question enough times and you begin to develop a set of pat answers, answers that serve to get you past the query and back to whatever you were doing before you were asked. I'm as guilty of this as anyone, but once in a while I'm forced to stop and think about these canned responses.
The other day a reporter asked me what I personally look for in an IPO. I gave her my tried and true spiel, but after she hung up the phone I found myself thinking more about the question. I had to admit that things on the IPO landscape were changing and what might have worked for me just a few months ago might not work today. I go through these exercises pretty frequently and usually I come away feeling a little more clear and a little more current on what's happening in the market. Despite any new trends or emerging themes that I recognize, I always end up circling back to a handful of maxims that, regardless of what changes occur in the IPO market, tend to hold true.
Many of these things I've said before, but I think they bear repeating. Here is a short-list of guidelines to keep you on top of the good deals and, hopefully, out from in front of any runaway trains.
Know the good guys from the bad guys.
Just like with my grocer or mechanic, I make it a point to do business only with those people I trust. You should know who is underwriting the deals you're buying. By sticking with the "name brand" firms, you're much less likely to get picked off by a lousy deal. The big firms, those that are bringing product to the market each week, year in, year out, owe a great deal of their continued success to their reputations. And guess what -- they know this! The bankers at top-end firms like
understand that there's very little upside in bringing a bad deal to the market. When the best private companies on the planet literally stand in line to have their IPOs underwritten by these elite firms, a few measly bucks in banking fees mean nothing when compared to the long-term earning potential of a strong syndicate department.
Know which groups or sectors are working.
A wise trader once told me -- and he was old enough to be the man who coined this phrase (Yes, Harvey, I was listening) -- "The trend is your friend." What he meant by this is that things that are working tend to continue working, at least for a while. This is definitely true of the IPO market. If software deals are trading up to huge premiums, then that's where you should be. Conversely, if a sector or group is dead, avoid it until it again begins to show signs of life.
When you're buying, know who is selling.
One of the first things I look for in a filing is the number of
shares being sold vs. those being sold by
. I immediately favor those deals where all of the shares are coming from the company itself. There are two reasons for this: First, the company receives all of the proceeds from the sale. Second, selling shareholders, especially in the IPO round, want out. In most cases, this makes me wonder why.
Look for a consistently improving balance sheet.
This was something I learned to rely on early in my career. Back when I was a broker at
I learned to read a prospectus. The one section I was taught never to skip was the one labeled Summary of Consolidated Financials. Here you'll find a table of revenues, net income and various other indicators of a company's general state of fiscal health. One of the quickest scans you can do is that of year-to-year revenue growth and net income (or loss) growth. In my version of the perfect world, I'd love to see both of these trend lines moving in a sharply upward direction. The reality, especially today, is that many (I should say most) companies seeking to raise money in the public markets are net income negative. This is far from optimum, but in the absence of profits I like to at least see a company ramping their revenues at a rapid rate. Fast revenue growth is no guarantee of eventual profitability, this I know. But, if I'm putting my capital at risk in a company that is losing money, I want the best assurance that it's at least gaining market share. Revenue growth, in most cases, is a reasonable barometer of this.
Scalability is king.
I love saying this and I firmly believe it to be true. If there is one single commonality in stocks that are true market leaders, it's that their business models are highly scalable. By this I mean that they are able to grow to reach very large markets. Think boutique shops vs. department store chains, then ask yourself, "Does this company scale?" If the answer is "no," then look elsewhere for your fortune.
Let's look at the deals for this week:
Ben Holmes is the founder of
ipoPros.com, a Boulder, Colo.-based research boutique (now a wholly-owned subsidiary of TheStreet.com) specializing in the analysis of equity syndicate offerings. This column is not meant as investment advice; it is instead meant to provide insight into the methods of new and secondary offerings. Neither Holmes nor his firm has entered indications of interest in any of the companies discussed in this column. Holmes' This Week in IPOs column appears Sundays, This Week's Secondaries appears Tuesdays, Upcoming Lockup Expirations appears Wednesdays and The Quiet Period appears on Fridays. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Holmes appreciates your feedback at