Rules of the Game: Use Caution With IPOs

 | Feb 08, 2013 | 12:30 PM EST  | Comments
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The young year has already been a busy one for IPOs. That's understandable as companies seeking capital prefer to sell shares in bullish rather than bearish (or sideways) market conditions, whenever possible. This week, the successful debuts of Boise Cascade (BCC) and ExOne (XONE) were in the forefront.

But use caution with IPOs. In other words, don't get swept up in the hype and the hope of getting into something early. It's very typical for IPOs to show significant gains in their early days and weeks of trading, and then fall below the offer price.

Much was made of Facebook's (FB) retreat, but that type of action is not unheard of. It just usually happens in small, thin stocks that nobody is following.

But Facebook had one thing going for it that many new stocks, including ExOne and Boise Cascade, do not: profitability. In my book, jumping into an unprofitable company, no matter how "hot" the product or service seems, is just a way to court disaster. (Dot-com boom and bust, anyone?)

Don't get me wrong: Stocks that went public within the past 10 or 12 years are often solid growth leaders. But "growth" includes the concept of earnings and revenue gains, which are key elements in a stock's long-term prospects for price appreciation.

One of my proprietary screens that I check every so often is called "Profitable IPOs." This includes companies that began trading since January 2010, so they are among the youngest companies on the market.

Familiar names, including Facebook, made it to this scan, as did stocks I write about frequently, such as LinkedIn (LNKD) and Michael Kors (KORS) .

The $16.4 billion animal-health company Zoetis (ZTS), which was spun off from Pfizer (PFE) last week, has also shown strong gains since its debut, and has been profitable since 2010. In fact, the company had earnings increases of 93% or more in seven of the past eight quarters.

Less well known is Russian search engine and Internet content company Yandex (YNDX) . The company went public to some opening-day fanfare in May 2011. But the stock has struggled since then; it closed Thursday at $24.50.

Its fundamental picture looks significantly better: The company grew earnings at rates ranging from 25% and 140% in the past eight quarters. Revenue increased between 29% and 77% during that time.

Yandex is slated to report its fourth quarter and 2012 results on Feb. 19, before the open. For 2012, Wall Street has pegged income at $0.84 per share, a 40% year-over-year increase. This year, analysts are eyeing earnings per share of $1.13, a gain of another 35%.

This is a volatile stock, and one that's yet to grab hold of any lasting upside traction. It's been more appropriate as a trade than an investment, so I'm not a fan.

Another technically volatile, yet profitable stock is Sensata Technologies (ST), a Belgian-based maker of sensors and other electronic controls that are used in the automotive, aerospace and other industries. Sensata went public at $18 in March 2010. It closed Thursday at $33.72.

The company has been profitable every year since 2009. Growth rates have been erratic over the past two years, but analysts are expecting earnings of $2.13 per share this year, up 9% over 2012. For 2014, that's seen growing 19% to $2.54 per share.

Sensata has a market cap of $6 billion, meaning it's too small to occupy a large slice of a portfolio. However, it could have a role as part of a balanced equity strategy.

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