Buy or Avoid Alibaba?
How to Find the Best-Performing IPOs
My Favorite IPO Stock
If I've been asked once, I've been asked a few dozen times: "Mike, what should I do once Alibaba comes public? Buy? Avoid? Buy small and then average up?" It's a good question, and I've answered it in a few different ways during the past couple of weeks.
Now, I realize we've had quite a few Alibaba-related Cabot Wealth Advisories of late, but I purposely waited until after the IPO to comment on the much-publicized stock. And I think you'll learn something as I explain how I aim to handle it (and all other) IPOs.
First, it's best to go back to the basics. As Paul Goodwin has so eloquently written in the past (and I've shamelessly copied over and over again), Cabot's growth stock investing system can be boiled down to a simple acronym: SNaC, which stands for Story (there must be a great, durable growth story at the company), Numbers (strong sales and earnings growth, big profit margins and big projections for future earnings) and Chart (a generally uptrending stock with volume support, telling us big investors are accumulating shares).
The key is to get all three in your potential purchases-it's not hard to find an enticing story, or a good chart, or a firm with good numbers. Heck, finding a stock with two of the three isn't all that hard. But I demand all three to be in place before considering entering a trade.
What does this have to do with Alibaba? Well, even though many investors treat BABA as a separate case (and it's true that you don't get companies coming public with $221 billion market caps often!), my thought is to treat everything the same-i.e., if I'm going to buy BABA, it's going to be because I put it through the same analysis I do with every other stock.
Alibaba obviously has a great story, as the dominant retail marketplace in China and with tons of a growth potential all over Asia. And the numbers are enticing, too-revenue growth is slowing a bit, but still registered 45% and 39% the past two quarters, while earnings rose 52% and 60% during the same quarters. The very early estimates see the company's bottom line up 30% this year and another 34% next-and both are likely conservative.
But what about the chart? Well, there isn't one! And that means I never buy an IPO right out of the gate. Instead, I wait for two things. First, I like to see the stock open very well, as Alibaba did, closing well above its offering price and holding those "gains." Second, and most important, I want to see the stock build an IPO base, something that the vast majority of successful IPOs have done before surging to great gains.
An IPO base is simply a relatively tight consolidation in a stock right after it comes public. It can be much shorter than a "regular" base (as few as three weeks long, compared to at least seven or eight for an established stock), but it shouldn't be overly deep (20% is a good limit). This type of calm, controlled, multi-week consolidation tells you that big investors are accumulating shares, building a sizable position for the months ahead.
One important point: Most of the best-performing IPOs also have great trading volume (trading north of $30 or $40 million per day, and ideally much larger), though there are exceptions. It can be a factor in determining whether to consider buying or not.
A great example of a short IPO base was Google (GOOGL) in 2004 (daily chart is below). Shares were priced at a split-adjusted 40 but ran north of 55 within a few days before forming a three-week shelf; the correction was just 13% from top to bottom. When GOOGL emerged to new highs in mid-September, it was buyable. The stock ran to 101 within two months before building a more normal base for a few months.
Another great example was MasterCard (MA), which came public in May 2006. Even though it was much talked-about, MA rose to a split-adjusted 4.9 a few days after coming public, and then moved straight sideways for two months in a tight 14% range. When MA gapped up in early August, it was buyable. It more than doubled by late November!
The last example wasn't as obvious but led to awesome gains. First Solar (FSLR) came public in late-2006, priced at 20 and closed its first day near 25, then ran above 28 a few days later. And then look at how the stock moved basically sideways from there-it poked up to 30 three different times, but effectively consolidated in a 10% range for about eight weeks. The breakout in late-January above 30 was buyable, and it gapped up on earnings in February. The stock was our biggest winner of 2007-2008, as we rode it north of 275!
These provide blueprints for what I'll be watching for from Alibaba-if the stock can consolidate between, say, the low- to mid-80s and 95 for three to eight weeks, and then break out powerfully, I think it will be worth buying a few shares. But not until then!
What intrigues me is that for all the hype surrounding Alibaba, there have been other big-story, big-numbers IPOs that formed bases and lifted off in recent weeks with considerably less fanfare. My favorite is GoPro (GPRO), which excites me because it's effectively created an entirely new industry-action cameras and videos. Here's what I wrote about the company in Cabot Top Ten Trader on September 8:
"GoPro is king of the wearable action camera. The company manufactures small, lightweight and extremely durable high-definition cameras that allow consumers to easily record their adventuring escapades and then just as easily post and share those videos and pictures online. GoPro's flagship products include the HD Hero and the Hero 3+, which can download footage into GoPro Studio, the company's desktop video editing application. The company also offers remote controls and integration with mobile devices via its GoPro App. Although the company's most recent quarterly report raised a few eyebrows, analysts expect GoPro to have a big holiday season, and this is what's behind the strength in GPRO shares, with analysts at Dougherty telling clients that "GoPro has established itself as one of the most valuable brands in consumer technology and has significant headroom to grow." For instance, during the 2013 holiday season, GoPro was sold in roughly 3,000 locations. Now, the company's cameras have shelf space at nearly every sporting goods and electronics retailer location! Lastly, the company is expected to realize significant growth overseas, a market which GoPro is only beginning to tap into."
The chart looks strikingly similar to some of the IPO base examples above-GPRO priced below 25 and soared to 50 after four days. Then it paused for seven weeks, though admittedly the range was wider than normal (25% or so). But given the huge run-up right after coming public, such a dip looked normal on the chart. GPRO exploded to new highs in late August and remains in great shape today despite the shaky overall market environment.
That shaky environment is the only reason I haven't bought in yet-I'm still seeing lots of "late-stage" evidence in the market that tells me risk is rising here, even as the Dow and S&P 500 are near their peaks. (The broad market is very weak, with five times as many stocks hitting new 52-week lows than highs, even on Wednesday's rally!)
Still, GPRO is a name worth watching; I wouldn't chase it up here, but another consolidation of two or three weeks, or possibly a dip back to or below 70, would be tempting to nibble.
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