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The Best Way to Profit from IPOs Right Now

12/2/2011 9:00:00 AM
By: David Sterman

We're in the final stretch of 2011, and I say good riddance! The market has been so volatile, I've exhausted my supply of Pepto Bismol. This up-and-down nature of the market is really evident when you examine initial public offering (IPO) deals. It's been cold, hot, cold and hot again. But I'm still convinced that it brings opportunities for investors to make money.

Indeed, the sharp market drop in August and September led many companies to quash their IPO plans in October. A robust market rebound in October led these companies to scramble to the IPO gate, causing November to have 13 IPOs -- highest number this year. Not surprisingly, renewed market weakness in November will likely close the window for IPOs in December. We'll probably have to wait until at least early 2012 before any major new IPOs hit the tape.

But you can still profit from the recent IPO rush by playing the "quiet-period bounce." Analysts who work at the firms that helped conduct an IPO must refrain from making any comments for 25 business days after the stock is priced. Considering less than 15% of all analyst recommendations are a "sell," you can count on subsequent reports that will gush about a newly-public company's growth prospects.

Positive Wall Street coverage can help spark a flagging IPO back to life. The key is to focus on stocks that haven't already taken off and are still trading near or below their IPO price.

Take Imperva (Nasdaq: IMPV ) and InvenSense (Nasdaq: INVNs ) , for instance. These two companies are already trading more than 45% above their IPO price, so it's highly unlikely analysts will come up with a fresh price target that's much higher than their current price. Notably, only one other November IPO is up more than 10% from the offering price, as you can see in the table above, so the "quiet-period bounce" could become quite pronounced in December -- if the broader market remains stable.

It's noteworthy that the biggest IPO of the month has been a total dud. Shares of Groupon (Nasdaq: GRPN ) were initially priced at $20, but saw such heavy demand that the stock opened at $28. After a brief spike above $30 on its first trading day, on Nov. 4, it has now fallen more than 40% from that peak. On that same day, I suggested Groupon's $18 billion market value made little sense.

What about its current $10.8 billion market valuation? I still think it's too rich, but I wouldn't short the stock just yet. Indeed, some analysts are likely to rave about the business model , mimicking the bullish tone that their investment-banking counterparts took when trying to sell this deal. That's an argument for going long for now and shorting the stock after research reports have been digested. (Look for reports around Dec. 9.)

Of course, some stocks are unlikely to move much at all as they are more about yield than capital appreciation . I'm talking about energy players such as EnduroRoyalty Trust (Nasdaq: NDRO ) , Chesapeake GraniteWash (Nasdaq: CHKR ) and agriculture stock Rentech Nitrogen Partners (Nasdaq: RNF ) . Of these, only Enduro is the only one likely to see a decent pop, because analysts are likely to suggest a target price at or above its $22 IPO price, implying perhaps 20% upside.

Yet two IPOs are surely worth a close look ahead of likely positive analyst coverage.

Auto parts maker Delphi Automotive (Nasdaq: DLPH ) has been the victim of continuing skittishness regarding the entire automotive industry. This apprehension has led shares of Ford (NYSE: F ) and others to perform under pressure for most of 2011 on fears of a looming slowdown. Yet actual monthly sales figures have been solid, and a preliminary read on November sales figures for cars and trucks implies another solid performance. I still expect the auto and auto-parts stocks to post a solid rebound in 2012, as the worst-case scenarios the market is anticipating don't come to pass. If this happens, then Delphi is likely to get a boost from this improving sector sentiment. The fact that you can get the stock for a 10% discount to the IPO price is an added catalyst .

I'm also quite intrigued by the recent drop in Angie's List (Nasdaq: ANGI ) , which had the bad fortune of following in Groupon's wake. Yet a market value that is just 6% of Groupon's tells you the bar is a lot lower for this provider of consumer reviews. Subscribers get real-time, candid feedback on local suppliers such as contractors, cleaning services and other local merchants -- sort of a Better Business Bureau that is more on the consumer's side and less on the business' side.

Right now, the company appears to have solid momentum, with third-quarter sales rising more than 40% to $63 million from a year ago, and 1 million subscribers in the fold. Perhaps the tepid IPO response is the result of fears that the company can't sustain such robust growth. After all, growth only took off in the past few years (thanks in part to pre-IPO funding that boosted the company's visibility). Its revenue base isn't large enough to generate profits, either.

To be sure, Angie's List faces rising competition and it's hard to know where the stock will be in a few years. It's a lot easier to guess where it will be in a few weeks. This is precisely the kind of stock that gets a solid lift from analyst research. Analysts are going to simplistically generate a two to three-year growth rate that mimics the recent growth. So look for projected sales growth of at least 30% in 2012 and again in 2013. This should be enough to show pro-forma profits and enough to justify a target price in the mid to upper teens.

This may seem like speculative meta-analysis, but it has happened hundreds of times in the past decade. At a minimum, it's overwhelmingly unlikely that any underwriting analyst will come out and speak negatively about this business model so soon after the IPO. The investment bankers and the underwriting firms hate to see such negative follow-on coverage. It hurts their reputation. So Angie's List may (or may not) be a good long-term investment, but it's more surely a good near-term trade.

Risks to Consider: What will December bring? More pain and misery for many stocks, I'm predicting. If so, then these IPOs could soon lose any momentum they have as investors tighten their portfolios to have only long holdings of established companies.

Action to Take-- > If you've been eyeing a recent IPO, then now may be the time to bounce, as imminent analyst coverage could provide a short-term boost.

-- David Sterman

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.