How to Invest in the 2014 IPO Market

[Editor's Note: This inside look at profiting from the 2014 IPO market was first published March 19 in Michael A. Robinson's Strategic Tech Investor.]

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High-tech IPOs are white hot right now, which is why many investors are trying to figure out how to invest in the 2014 IPO market.

But it's easy to look in the wrong places for IPO profits...

For example, over the last month or so, I'd bet that I've seen three or four dozen stories about the initial public stock offering of King Digital Entertainment, the company that markets the smash-hit "Candy Crush Saga" game for smartphones.

And with every single story I just shake my head and grin.

I grant you that King Digital is currently a better financial proposition than, say, arch-rival Zynga Inc. (Nasdaq: ZNGA) - which is rolling up losses in a way that should scare investors away.

But as alluring as the IPO market can be, it's not a place to play unless you have the "connections" needed to access the best deals - or have a special "angle" to play.

I can't help you with the connections.

But I can give you that special angle.

And that angle will give you access to the profits that roll out of the IPO market - but at a much lower level of risk.

Here's how.

An Insider's View

As a tech-sector insider, I've watched, played, and profited from IPO deals for years. So I understand the allure. I mean, who wouldn't want to pull down a year's worth of profits from the one stock-offering deal that everyone has been talking about?

And right now, the allure is as strong as it's been in years.

In that regard, 2013 ranks as a milestone in the five-year rally from when the market hit bottom in early 2009.

Market research firm Dealogic says there were roughly 230 U.S.-listed IPOs issued last year - a 58% increase from the 145 deals of 2012 and a high-water mark that came five years after the bear-market bottom of 2009.

Those offerings raised $61.7 billion, up 31% from a year earlier - and the largest annual haul since 2007.

Tech investors were especially well rewarded. Although these stock offerings averaged a 33% return, the tech-focused deals generated an average gain of nearly 60%, Dealogic says.

As good as all that sounds, the best is yet to come. A recent report by consultant Ernst & Young says 2014 is shaping up to become a "record year" for worldwide new issues.

"The strong recent uptick in listings indicates a recovery in investor confidence and better market fundamentals," the report says. "The overall trend is an improving one, and activity should trend noticeably higher in 2014."

Little wonder folks are drooling about the King Digital deal, which could value the company at $7.6 billion.

But there's just one problem...

Most retail investors won't profit from this deal ... because they'll never get a piece of it.

An Insider's Game

It's a hard reality to accept: If you're not an "insider" - like the venture capitalists, investment bankers, or early employees who have a connection with the company, and were granted shares in return - you'll be watching from afar when an IPO makes its debut.

And even if you had a shot at some of the small allotment that makes its way to brokers, keeping track of when a new issue is to hit the market is really tough for an individual investor to do.

It's not unusual for both the timing and offering price to change several times in the weeks before the IPO begins trading.

Given all these factors, most retail players end up buying the stock after it starts trading - at the inflated post-offering price. That means you can easily lose money - even a lot of money - if you snag the shares at their peak, and then watch them close down from that apogee for the session.

But don't worry: there's a better strategy for investing in IPOs ...

A Rare Market-Beating Bargain

A year ago, when I saw that the IPO market was accelerating, I set out to find a way for retail investors like you to cash in - without getting burned.

And I quickly found what I was looking for.

My "solution" - the First Trust IPOX-100 Index Fund (NYSE: FPX) - is an exchange-traded fund (ETF) that focuses on IPOs. And though it doesn't specialize just in tech stocks, it does attempt to reflect the broad market for new issues.

I like to think of this play as a "twofer:" You get some hot new tech offerings and broad diversification with a fund that owns a total of 100 stocks. FPX also holds positions in finance, auto, retail, heavy industry, energy, and even metals.

Because this is a "rules-based" ETF, the managers don't let themselves get caught up in all the hype that can surround some IPOs. For instance, the fund only invests in a stock after doing a thorough review of the company's financials and never buys on opening day. And it sells each stock after holding it for 1,000 days.

By definition, the ETF doesn't invest heavily in the sexiest small and micro-cap firms. Instead, it is weighted toward mid-caps that have an average market valuation of roughly $3.3 billion.

With this approach, the fund puts money into firms still small enough to offer a hefty upside - but still large enough to avoid the high volatility of more thinly traded stocks.

Consider that two of its largest holdings have greatly outperformed the broader market over the past year. Facebook Inc. (Nasdaq: FB) is FPX's top holding, comprising nearly 12% of the fund. After a disastrous 2012 IPO, the stock is up 150% since March 2013.

Over the same 12-month stretch, electric carmaker Tesla Motors Inc. (Nasdaq: TSLA) returned an astounding 525%. Tesla shares account for about 3% of FPX, meaning the stock ranks as one of the ETF's Top 10 holdings.

One of the things I really like about this fund is how it balances its big caps against smaller firms in a way that gives its investors access to some really good companies in high tech and the biosciences. Holdings include:

  • NXP Semiconductors NV (Nasdaq: NXPI), one of the Top 20 companies in the world for sales of semiconductors. NXP is involved in some of the best growth markets, including mobile and wearable technology. Over the past year, the stock has gained roughly 85%.
  • Splunk Inc. (Nasdaq: SPLK), a Big Data software firm. Splunk's products help clients in the collection, monitoring, analysis, and use of huge data sets - an evolving field with some incredibly exciting applications. Even after a recent 12% correction, the stock has a one-year return of 115%.
  • Pandora Media Inc. (NYSE: P), a global leader in streaming music. Pandora lets users create and customize what amounts to their own Internet radio stations. This stock shows one of the hazards of buying a single IPO. It has more than doubled in the past year. But in its first 18 months' of trading, the stock crashed by 54%.
  • Clovis Oncology Inc. (Nasdaq: CLVS), a biotech firm working to develop cancer treatments. Clovis is currently focused on compounds for treating cancers of the lungs, ovaries, and breasts. Over the past year, the stock is up 181%. But like Pandora, it also demonstrates the risks of single-stock IPO investing: Since March 2013, Clovis has racked up five corrections - with losses ranging from 10% to 34%.
  • Palo Alto Networks Inc. (NYSE: PANW), a Silicon Valley software company specializing in cybersecurity. Palo Alto's "firewall" products give protection to big companies and major government agencies. After losing 20% of its value in 2013, the stock is up nearly 40% over the past year.

Now you know why I think of FPX as a "no-brainer" way to invest in the 2014 IPO market. The fund keeps you from experiencing the gut-wrenching rollercoaster rides that often define the first few months of a new stock's life. And that keeps you from getting old before your time.

And it does this while helping you grab shares in companies at prices that you might otherwise not get.

Now trading at around $47.10, we view the FPX ETF as the single-best way for most investor to cash in on the burgeoning IPO market.

It offers a regimented approach to the new-issues market that is less risky than individual IPOs, but that can still give you one heck of a return: The ETF has returned 36% over the past year - almost exactly a double the performance of the Standard & Poor's 500 Index during the same period.

In short, this is one of those ETFs that - years from now - you'll be giving thanks for having bought.

NOW: A "forbidden" market is about to crack open. These companies and their investors are looking at unprecedented money-making opportunities...

About the Author

Michael A. Robinson is one of the top financial analysts working today. His book "Overdrawn: The Bailout of American Savings" was a prescient look at the anatomy of the nation's S&L crisis, long before the word "bailout" became part of our daily lexicon. He's a Pulitzer Prize-nominated writer and reporter, lauded by the Columbia Journalism Review for his aggressive style. His 30-year track record as a leading tech analyst has garnered him rave reviews, too. Today he is the editor of the monthly tech investing newsletter Nova-X Report as well as Radical Technology Profits, where he covers truly radical technologies – ones that have the power to sweep across the globe and change the very fabric of our lives – and profit opportunities they give rise to. He also explores "what's next" in the tech investing world at Strategic Tech Investor.

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