I plan to make 2012 my best year yet by not buying into the hype of popular IPOs. Last year was jam-packed with stock market debuts from a variety of businesses. From trendy startups like social game developer Zynga (NAS: ZNGA) to daily deals darling Groupon (NAS: GRPN) , it seemed each new offering was bigger and better than the last.
Not sure which investments are worth the hype? You're not alone. Looking to the year ahead I've laid out some guidelines for analyzing worthwhile IPOs. While these aren't rules set in stone, they can help you evaluate companies before blindly jumping in.
According to The Economic Times, "two out of three IPOs that hit the market in 2011 offered negative returns to investors." Of these newly traded securities, 19 were social media companies. It's no secret that social media businesses got loads of buzz last year. What's really unsettling is that so many investors (including myself) were willing to buy in despite a lack of historical data on the new breed of companies.
For this reason, investors should review the S-1 form filed with the SEC by IPO hopefuls prior to their initial offerings. The S-1 registration can help investors identify the merits of an offering and make better judgment calls on companies that are new to the game.
However, reviewing the S-1 is far from the only thing investors should do before picking up shares of an IPO. In fact, those who read Groupon's S-1 were likely to learn that the deal-of-the-day website misleadingly disclosed the total number of customers having ever bought a Groupon deal in a portion of the S-1 clearly reserved for quarterly results.
Information presented in the S-1 should be straightforward and clearly defined. The fact that Groupon went out of its way to make its S-1 reports extra confusing should be a major red flag for investors.
At last look, Groupon's shares are below its $20 IPO price. A stock that's fared even worse than the deal dynamo is Internet music streaming site Pandora (NYS: P) . At the start of trading, Pandora soared to more than $25 a share, increasing nearly 50% over its initial offering price of $16 a share. Today the stock is singing the blues, with its share price weighing in around $10.
Avoid the short end of the flip
Often, a company will enjoy huge gains in its first day of trading only to fall flat once institutions take their profit. Such was the case with LinkedIn's (NAS: LNKD) initial public offering, which enabled big funds to get a piece of the action at $45 a share only to sell on the open market at $85 a pop.
For investors that followed LinkedIn's hype to a loss, it's important to remember this can also happen after a public company's lock-up period expires. Before a company can become publicly traded, insiders must sign an agreement stating they won't sell shares of stock for a set amount of time known as the lock-up period.
Unfortunately, LinkedIn was a textbook example of what can happen when the lock-up period ends. Shares of the social networking company tumbled to their lowest point in five months following the period, as employees rushed to profit from their stake in the newly public company.
Do your research and make sure you know what the agreed upon time frame is for the company's lock-up period. This way you can better avoid a sudden downturn in the stock price.
On the upside
Rest assured, we can expect even more overhyped IPOs in 2012. Use the extra publicity to propel your research of a company forward. Under the layers of fluff surrounding Zynga's IPO, I uncovered one major difference between the game maker and other Internet companies that went public last year.
To my surprise, Zynga CEO Mark Pincus had organized the offering in such a way that allowed him to retain his own Class C shares that let him keep power over the company once it went public.
As a result, each share of C-class stock gave Pincus 70 times more voting power than shares sold in the IPO -- a stark contrast to the more common 10-1 voting ratio that companies like LinkedIn have used for their offerings.
Start 2012 off right
Another year, another set of IPOs with high hopes and valuations. This year, don't aspire for a piece of a half-billion-dollar IPO -- instead take some time to reflect on the quality of your investments. Ring in the new year and tell me in the comments below what you won't be doing in 2012.
- Add Zynga to My Watchlist.
- Add Pandora Media to My Watchlist.
- Add LinkedIn to My Watchlist.
- Add Groupon to My Watchlist.
At the time this article was published Fool contributor Tamara Rutter does not own shares of any of the companies mentioned in this column. Follow her on Twitter using the handle @TamaraRutter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.