Tuesday, July 04, 2006

What to look for in IPOs. Part I

This series will explore some thoughts about IPO investing. IPO investing is about taking advantage of your ability to outrun the institutional investors and so take advantage of pricing inefficiencies. This isn't hard to do, because most institutional investors rely on sell-side research, which is squelched during the pre and post IPO quiet period. Unless an IPO company is famous, (like J-Crew) or obvious (Anything energy related), everyone is working off of the same set of data in the SEC S-1 forms.

But no one wants to read S-1 forms because they are long and boring, so if you are willing to put in the time and effort, you can have an information advantage over many other market participants. Counteracting your potential information advantage is the desire of everyone else involved in the IPO to have the IPO go off at a high price.

Some things exist which counteract this desire. The main contra force is market sentiment. If Mr. Market isn't interested in new companies being offered, then IPO's will be priced downwards. This can also work in reverse as well. There isn't anything you can do about market sentiment other than to be aware it.

The other big contra force is ignorance. What makes ignorance so powerful is that it is so often underestimated, especially by the ignorant. The nature of most economic research is that researchers start with a theory or model, and then go out to collect data to verify it. Without models and without data, most economically trained folks are lost. That's exactly the situation with an IPO.

Since IPO companies tend to be in transition which makes comparisons with the past or future very difficult, it is especially difficult to build models and find data to populate the model. This is where qualitative skills shine through. The ability to look at a bunch of data and get an accurate impression of it, is what separates the men from the boys.


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