The Only Way To Invest In This Red-Hot IPO Market

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If you haven't noticed, the IPO market is on fire. 

As has been the case for a number of months, the most recent crop of newly public companies are posting stellar after-market gains. With the exception of a tepid after-market performance for data storage firm Violin Memory (Nasdaq: VMEM) , the investor reception has been impressive.

September's Most Popular IPOs

Yet there are two things you should know about when it comes to these companies. They face a potential post-trading stumble in the weeks ahead and another in a few quarters. And they explain why you should wait for these stocks to come back into earth before giving them a fresh look. (And why, if you have been lucky enough to own them from the IPO, this is a good time to sell.) 

The 'Kitchen Sink' Quarter
As investment bankers help a company to go public, they impart one simple message: Make sure you generate solid results in your final quarter as a private company -- which investors will be heavily scrutinizing ahead of the IPO. And deliver a great quarter the first time around as a public company.

Another common banker refrain: You'll never get investors back on board if you deliver lousy first-time results.

The bankers have their own selfish agenda. They've promised the investors that bought into the IPO that they've done their due diligence and the numbers pitched in the deal can be trusted.

As a result, these newly public companies pull out all the stops and make sure the numbers look good. Yet that pressure to generate great numbers in the pre- and post-IPO quarters makes it that much harder for companies to keep it up. That's why so many companies appear to stumble badly, only one or two quarters after their IPO. Indeed picking up shares of a hot IPO several months down the road, once the bad quarter is out of the way, is often the better strategy. 

Big Data vendor Splunk (Nasdaq: SPLK) is a great example. Though investors initially pumped up shares of this company based on its solid long-term growth opportunities, they abandoned ship when Splunk delivered tepid results in the third quarter of 2012, its second quarter as a public company.

A clear exception to this cautionary approach can be made for companies that slump right after the IPO. Analysts tend to issue gushing reports when the 25-day "quiet period" ends, mimicking the bullish upside envisioned by the company's investment bankers, which can lead to as solid pop in the stock.

Data storage firm Violin Memory is a great example. To get the deal done, the company's bankers came up with target prices in the low teens, nicely above the $9 offering price. (IPO buyers need that kind of baked-in upside spelled out for them.) Well, shares are now down below $8, yet you can expect the analysts to simply reiterate the bankers' view that shares are worth $12 to $14, based on peer group comparisons. 

That doesn't make Violin a good investment, but it makes for a good trade ahead of the wave of analyst "buy" ratings. 

The Lockup Frenzy
The fact that 2013 has been a banner year for IPOs also means that investors may soon start getting tripped up by the 180-day waiting period, known as the lockup, when insiders are free to start selling shares. That means any company that went public in April, May or June could see significant selling pressure as we head towards the end of the year. (That also means that these stocks will be fresh bargains when the wave of selling ends.)

Here's a quick look at some high-profile springtime 2013 IPOs that could take a steep hit from insider selling.

Time to Lock In Profits?

There are some very promising young companies in this group, but this liquidity-fueled market has pushed their shares up to levels that even the most bullish investment bankers could not have foreseen. 

For the insiders at these companies, many of whom are now sitting on tens of millions of dollars in paper gains, the urge to sell could prove overwhelming. If that scenario plays out, then these stocks should surely be on your research list for the post-lockup bounce. 

Risks to Consider: These young companies haven't been public enough to establish a solid long-term base of shareholders. They're also especially vulnerable to a shift in market direction.

Action To Take --> With the IPO market now on full boil, it pays to heed these long-standing post-IPO trading practices. In many instances, you'll be able to buy these companies at better prices after they've gotten through this weaning phase.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

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