In September, I wrote an article detailing the reasons why investors shouldn't buy shares in the Hyatt (NYSE:H) IPO. At the top of the list was my argument that the hotel chain was simply going public to raise some cash for the Pritzker family, who control 85% of the shares. I reasoned that you'd be nuts to buy the stock because you were simply padding the Pritzker's bank accounts doing nothing for the hotel chain. Since its public debut November 5, Hyatt stock is up 18%, two-thirds of it on its first day of trading. While this ship has sailed, let me give you a piece of advice for the next IPO you might be considering. Only subscribe to those where a majority (60% or more) of the net proceeds go to the company and not to selling shareholders. The evidence suggests this is one of the best predictors of IPO success. (For a quick refresher, check out IPO Basics: What Is An IPO?)
A Shared Trait
If you take the best performing IPO in the United States for each of the years between 2005 and 2009, you will find that all five share one common trait: selling shares to the public with little or no cash going into the pockets of existing shareholders. Instead, the owners have wisely concluded that the long-term growth of the business will ultimately provide them with far more wealth than any temporary cash grab would. Below, I've included a table that lists the top performing IPO in each of the last five years, the percentage gained in the year of issue and the total return since its IPO. The results are quite conclusive.
Top Performing IPO 2005-2009
|
Company
|
IPO Year
|
Return - IPO Year
|
Total Return
|
Relative to Wilshire 5000
|
|
Citi Trends (Nasdaq:CTRN)
|
2005
|
205%
|
100%
|
101.6%
|
|
Riverbed Technology (Nasdaq:RVBD)
|
2006
|
215%
|
121%
|
135.2%
|
|
JA Solar (Nasdaq:JASO)
|
2007
|
360%
|
(72.6%)
|
(50.0%)
|
|
Grand Canyon Education (Nasdaq:LOPE)
|
2008
|
56.5%
|
62.4%
|
20.5%
|
|
Duoyuan Global Water (NYSE:DGW)
|
2009
|
152.4%
|
152.4%
|
128.9%
|
A Couple Of Caveats
With the exception of Citi Trends, which reinvested 65.2% of its net proceeds, the remaining four leaders all put 100% of the funds raised back into their businesses. Grand Canyon chose to pay a special dividend to all shareholders of record on November 18 to the tune of $94.5 million. While you always prefer that the funds go directly into operations, companies make these special distributions as a way to thank long-time shareholders while keeping them in the fold. It doesn't always work, but in this instance, I believe it has. LOPE's largest shareholder at the time of its IPO, Endeavour Capital, still owns 5.4 million shares or 11.8% of the stock. While down from 22.1% at the time of the IPO, most pre-IPO investors are gone one-year later, so on balance, it's a wash. At the end of the day, its stock is performing.
Bottom Line
Investing in IPOs is never a sure thing. You just never know how they're going to turn out. However, in order to give you a fair shot at success, the evidence is crystal clear. Only invest in IPOs where the companies are already making money and where most of the proceeds go to funding the business itself and not the existing investors. (For further reading, check out IPO Basics Tutorial and How Does An IPO Get Valued?)
