The Secret to Raking in IPO Gains in 2012

There’s been a lot of attention on the IPO market in 2011 — and for good reason. With high profile social media companies like LinkedIn, Groupon, and Zynga going public this year with multibillion-dollar market caps, investors want to know if they’re looking at the next Google, or — gasp — the next Pets.com.

To be sure, it’s been a big year for initial public offerings (better known as IPOs). All told, year-to-date IPO announcements are up more than 86% versus last year, with 631 firms filing to make their shares publicly traded as of this morning’s open. But that positive trend in IPOs is hardly the whole story…

#-ad_banner-#In case you’ve been living under a rock this year, you already know how gut-wrenching stock performance has been so far this year. Historically, bad market conditions mean lower values for IPOs, so companies and their underwriters avoid going public when stocks are under pressure as much as possible. As a result, withdrawn IPOs are up 66% versus last year, as financially sound firms pull the plug on their offerings until Mr. Market looks a bit friendlier.

Those who haven’t — the Groupons, LinkedIns, and Zillows — have gotten absolutely shellacked this year since they started trading. And so have their shareholders…

Yes, it’s true that IPOs can hold the keys to truly outsized gains (imagine buying Google back when it cost $85 — now it’s $628 as of this morning’s open), but they’re clearly also fraught with risk right now. Should you avoid IPOs altogether in 2012?

No. But you’ll have to sift out the wheat from the chaff to find gains in newly public stocks in the new year.

While the most-hyped IPO names of 2011 have seen their share prices summarily whacked, smaller IPO names have fared a whole lot better this year. Take nutritional supplement retailer GNC Holdings (NYSE: GNC) for example; this stock was a small-cap when it went public, and investors who bought early have seen their positions rally nearly 68% since March.

Taking a look at the names below, there’s clearly a trend in what’s make an IPO successful in 2011:

Looking at the table above, a few common threads become very clear. For starters, each of the top gaining IPOs of 2011 have been small-cap stocks. Contrast that with the hyped-up names like Groupon, which is down double-digits and went public with a $16.7 billion, or Renren, which is down nearly 82% on the year after offering at a $5.5 billion market cap. Without the hype and over-analysis of Wall Street, smaller firms had more upside to offer investors this year.

#-ad_banner-#Another important trend is the industry that the winners are operating in…

While most of the attention has been on high-tech social media names such as LinkedIn or Thursday’s Zynga IPO, most of the top performers of 2011 are actually in comparatively boring businesses. It’s not that boring is inherently better for investors — instead, the key is that investors are more competent at valuing the fundamentals of a retailer or an energy firm than they are at valuing a tech firm with no profits and lots of intangible assets.

From a due diligence standpoint, it makes sense to focus on industries that we can get reasonable assurance over rather than the high-risk, low-reward tradeoff being offered up by tech names right now.

Despite all appearances, there are clearly still opportunities to be found in IPOs. With 2012 on the horizon, it’s going to be crucial to focus on IPO names that meet the criteria of the recent winners, not the hype that the media is focusing on. Stick with small-cap names in boring industries on your next IPO hunt, and you’ll be better off.