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A Serious Warning to Amateur Investors

By Larsen Kusick, analyst, Phase 1 Investor
Monday, November 28, 2011

"Everybody wins. You get rich. The investment bankers get rich. The mutual fund manager collects a huge salary and bonus, and the public learns a valuable lesson... that only idiots buy IPOs."
Last week, I received this note from a friend of mine. We were talking about one of Wall Street's favorite ways to fleece the average investor... the IPO process.
As you can tell, my friend, a long-time investment professional, has a cynical view of IPOs.
And I imagine folks who bought some of the past few year's biggest IPOs – LinkedIn, Groupon, and Pandora Radio – will soon have the same view. These buyers are getting killed... and will likely continue to get killed by taking one of the market's most popular – and most dangerous – trades.
If you're not familiar with IPOs, they're simple. They're "initial public offerings" – like the "introduction" of a new publicly traded company.
There's nothing necessarily evil about a company going public. It's a way for companies with big growth plans to access the capital markets. The problem is there's a line of people – from the business owners to the investment banks – interested in making sure that they unload their share of the company, which they probably purchased very cheaply, to you... at a massively inflated price.
One of the keys to getting a big price tag is to highlight a company's growth... actual profitability is often sidestepped. And part of the IPO process involves research firms estimating future revenues and earnings. Of course, the "research firms" are usually part of the same investment bank that is getting big fees to bring the company public.
So you'll often see super-high growth numbers well above what the company can deliver immediately... or ever. When that's finally clear to the public, you'll see the sky-high valuations fall back to earth.
And that's exactly what we're seeing with a few of this year's "big name" IPOs:
Date of IPO
Close on First Trading Day
Current Price
Groupon (GRPN)
Skullcandy (SKUL)
Zillow (Z)
Pandora (P)
LinkedIn (LNKD)
Note the first company on the list, Groupon. It's the popular "e-coupon" site. Despite concerns of questionable accounting practices and competition flooding its market, it was a hugely successful IPO... which placed the company's value at over $12 billion. Keep in mind, Groupon lost $414 million last year. Hype ruled the day.
Remember... each of these IPOs generated hundreds of millions of dollars for the people involved. Company insiders cashed out, investment bankers collected huge fees... even the mutual fund managers who bought shares will take home bonuses this year. But the individuals who showed up late and bought the hype were soaked.
You can make money as an investor in growth stocks... but participating in popular IPOs is almost always a horrible way to go about it. Think about it: you're buying shares of often unproven companies from informed insiders at hyped-up, inflated prices. The results from this year's biggest offerings are just the latest demonstration that it rarely pays to buy what Wall Street is hyping.
Good investing,

Further Reading:

Larsen believes a better place to put your money is in the biggest U.S. energy shift of the Millennium. The trend is still small, but it's already headed in the right direction... And some of the world's biggest companies are already going "all-in." Don't miss Larsen's favorite ways to play the trend here.

In The Daily Crux
Market Notes
U.S. dollar index is up 6% in a month… euro index is down 6.5%.
Uranium giant Cameco drops to a new 52-week low… down 62% from its high this year.
Energy sector drops from overbought levels to oversold in a week… Amex oil index is down 11% in that time.
Bank of America hits a new low… The finance giant has dropped from over $15 a share early this year to $5.17.
Market Watch
Symbol Price
S&P 500 1158.67 -0.3% -3.3%
Oil (USO) 37.16 +0.0% +3.0%
Gold (GLD) 163.40 -0.9% +21.8%
Silver (SLV) 30.20 -2.4% +12.1%
U.S. Dollar 79.63 +0.7% -0.1%
Euro 1.32 -0.8% -0.9%
Volatility (^VIX) 34.47 +1.4% +76.2%
Gold Stocks (^HUI) 528.39 -1.3% -3.8%
10-Year Yield 1.97 +4.8% -32.3%

World ETFs
Symbol Price
USA (SPY) 116.34 -0.2% -1.3%
S. Korea (EWY) 49.52 -0.5% -9.9%
Japan (EWJ) 8.84 +0.0% -14.0%
Canada (EWC) 24.96 -1.2% -14.3%
S. Africa (EZA) 57.01 +0.4% -14.4%
Taiwan (EWT) 11.51 -0.3% -16.5%
Singapore (EWS) 10.85 -1.0% -16.6%
Israel (ISL) 12.93 -1.0% -20.3%
Lat.America (ILF) 39.92 -1.6% -22.0%
China (FXI) 33.33 -0.2% -23.0%
Russia (TRF) 14.50 -0.1% -29.6%
India (IFN) 20.68 +0.4% -34.4%

Sector ETFs
Symbol Price
Utilities (XLU) 33.43 +0.5% +12.2%
Big Pharma (PPH) 65.40 -0.3% +7.1%
Retail (PMR) 19.97 -0.7% +3.9%
Health Care (IYH) 65.23 -0.7% +3.9%
Consumer Svcs (IYC) 66.49 -0.3% +1.3%
Big Tech (QQQQ) 52.88 -0.8% +0.3%
Real Estate (IYR) 51.60 +0.4% -1.5%
Industrials (IYJ) 58.44 -0.2% -3.5%
Internet (HHH) 68.90 -1.9% -5.0%
Defense (PPA) 16.79 +0.1% -6.2%
Software (PSJ) 22.46 -1.7% -7.2%
Transportation (IYT) 80.84 -0.7% -7.7%
Media (PBS) 12.06 -0.2% -8.2%
Telecom (IYZ) 19.59 -0.3% -9.1%
Construction (PKB) 10.61 -0.8% -9.6%
Insurance (PIC) 13.97 +0.0% -9.8%
Biotech (PBE) 18.07 -1.2% -11.8%
Oil Service (OIH) 112.85 -0.3% -12.1%
Water (PHO) 15.52 -1.0% -13.6%
Basic Mat (IYM) 60.31 -0.6% -13.9%
Financials (IYF) 44.42 +0.4% -15.3%
Semis (PSI) 12.74 -1.1% -18.4%
Nanotech (PXN) 5.79 -1.0% -41.7%
Alt. Energy (PBW) 5.03 -2.0% -48.9%

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