3 Ways to Juice Returns With IPOs

We’ve seen some red-hot initial public offerings this year. 3-D printing machine maker ExOne (NASDAQ:XONE), for instance, has surged 76%, while online money transferring service Xoom (NASDAQ:XOOM) has zoomed up 44%.

Sure, these returns might not be on par with the giddy 1990s — when it was routine for IPOs to double or triple within months — but these offerings are still impressive enough to be sought-after by investors.

The problem: Most investors are shut out of IPO allocations. The shares are mostly for favored clients of the investment banks, leaving retail investors little choice but to make trades once shares actually hit the market — thus leaving them out of the big first-day pop.

Don’t despair. There still are ways to make a buck off IPOs.

The IPO process is highly regulated and structured, allowing investors the chance to time events that can have a big effect on the stock price. Usually, these opportunities exist as signals to short companies.

Let’s take a look at three strategies:

Broken Deal

The first day of an IPO is usually a media-filled event, with hype the norm. But in some cases, a deal will run into trouble. And if the IPO falls below the offering price, it is referred to as a “broken deal.”

The underwriters actually have the ability (and are cleared by federal regulations) to make stabilizing bids to prop up the shares. In this case, the IPO might remain near the offering price, but the event is considered a negative sign. A broken deal means investors aren’t thrilled with the prospects of the company, and the stock is likely to see ongoing weakness. This creates a nice opportunity to go short.

You might have seen this during the Facebook (NASDAQ:FB) IPO, when the stock went unchanged on its first day of trading. Despite the efforts of the underwriters, there was not enough firepower to stabilize the stock, and shares plunged from $38 to $20 during a four-month period.

Ahead of the IPO, few would have thought of shorting the mighty Facebook. But when the IPO turned out to be a “broken deal,” it certainly got the attention of the shorts.

Quiet Period

This means the underwriters of a company cannot issue research reports until 40 days after the deal hits the market. Not surprisingly, the analysts are often bullish after those 40 days, resulting in a surge of “buy” recommendations. This usually creates a pop in the stock of about 5%, as the generally limited number of shares on the market makes the price move easier.

Another way to play the quiet period is to note any “neutral” or even “sell” recommendations. But be wary: It takes a lot of guts for analysts to make such a recommendation, and there’s a good chance that the company is facing serious problems.

This was the case with Groupon (NASDAQ:GRPN), which garnered weak coverage from its underwriters. Within six months, the shares would go on lose about 60% of their value. It turned out to be another short opportunity for alert IPO investors.

Lockup Period

This is a contract between the underwriters and insiders that prevents the sale of shares. In most cases, it lasts for six months after an IPO. The rationale behind the lockup is to hold back massive selling during the early stages of a deal.

However, it usually does nothing to soften the blow — when the lockup period expires, shares will usually drop. Interestingly enough, the selling generally takes place a week or so before the expiration.

If the company is solid — and still has strong growth prospects — this could be a great entry point to buy shares. Take LinkedIn (NYSE:LNKD), for example. About a week ahead of its lockup period expiration, the shares fell 10% to $70. For those who wanted to get a great social networking company, this turned out to be a good entry point. Within four months, the stock price was more than $100.

Bottom Line

As with any trading strategies, nothing is guaranteed, and that’s especially the case with the traditionally volatile IPO market.

Yet, over time, you’ll begin to see some general themes and trends with the timing of key events. Playing these trends the right way can help you get better prices on shares — or to find some lucrative short-sale opportunities.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of “How to Create the Next Facebook” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders.”Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/ipm_ipo_pb/3-ways-to-juice-returns-with-ipos/.

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