Beat the Brokers at Their Own Game and Make a Mint in the Process!

by Siu-Yee Ng

The IPO market lives and dies by the NASDAQ. And with the NASDAQ in bear country, we’re seeing little action in IPOs. The NASDAQ has to regain lost ground before the IPO market can recover.

But here’s the good news: the bear market will eventually end.

We know that the NASDAQ has been in a bear market. But bear markets follow a pattern. There’s the initial fall, followed by a rally, followed by total capitulation and despondency as panicked shareholders sell everything.

And according to Dow Theory, it takes an average of 18 months for a bear market to end. One can argue that the recovery is taking longer than expected because of the September 11 attack and the uncertainties of the war on terrorism.

But it looks as if the market hit bottom after the September 11 attack, and happy times will soon be here again. We want to be well positioned to take advantage of the recovery.

In this year’s forecast issue, I will do three things for you. I’m going to show you why IPOs are Wall Street’s dirty little secret… designed to milk investors out of millions, and to make brokers rich. I’m going to show you how never to be burned in an IPO again. And I’m going to show you a proven method for profiting from IPOs.

Wall Street rats

There’s a technique that Wall Street professionals are taught to use against you… to scam you… and to walk away with your money.

In fact, you’ve probably been hit with this trick–and you don’t even know it. Worst of all, these Wall Street rats get away with it. It’s perfectly legal!

When brokers get their hands on the group of stocks I’m about to tell you about, they’ll squeeze you dry. I’m talking about IPOs.

In my opinion, the IPO market is the biggest scam since your neighbor had a dinner party and started telling you about his Amway "pyramid scheme." Think that’s a swindle? It doesn’t even come close.

You’ll soon agree.

Don’t get me wrong. Not all IPOs are bad investments. And if you had invested in enterprises like Microsoft and IBM when they were obscure new companies, you could have retired early. But you do need to know how to avoid the dog stocks like Pets.com and Garden.com.

In fact, if you learn nothing else in this report, do me this favor: If your broker calls and asks you to buy an IPO stock, hang up, and immediately fire his butt!

Why? Let me show you how it all works…

Because then you’ll know for sure that your broker is using an unspoken technique to milk you for every cent you have!

Con artists

I don’t care how well you know your broker, he’s laughing at you. In fact, he’s probably laughing all the way to the bank.

You see, there’s a practice on Wall Street called "flipping."

Briefly, "flipping" is a way for brokers to load up on a pre-IPO stock at pennies on the dollar. Once the stock goes public, they call and try to sell it to you.

Thousands of brokers do this, pushing the stock higher and higher on the first day of trading. How do I know this? It’s very simple.

You see, 1999 was the greatest IPO market ever. It was also the greatest Wall Street rip-off ever. And it wasn’t a coincidence that both occurred in the same year. Brokers were making more money than they could spend. And why not?

117 IPOs doubled in price on their very first day of trading in 1999.

Now let me put that into perspective for you. Out of all the IPOs from 1974 to 1998, only 39 doubled on their first day of trading.

That’s 39 in 24 years… compared to 117 that doubled in 1999 alone! Again, that wasn’t a coincidence. It was designed that way!

Point is, unless you are a broker, the IPO market is 100% rigged against you.

You’re better off going to Vegas and plopping down US$1,000 on the roulette table… because your chances of making money on roulette are better than making money on an IPO.

That is, if you’re not using the brokers’ own "flipping" technique against them. You see, understanding how brokers use this trick could make you a mint on IPOs.

I’ve been using this "reverse flipping" trading style for years. I recently profited from trades like Finisar Corp. (FNSR:NASDAQ)–a 119% profit in 3 weeks; Foundry Networks (FDRY:NASDAQ)–a 67% profit in 3 weeks; and XM Satellite Radio Inc. (XMSR:NASDAQ)–a 141% profit in 7 weeks!

First they rise, then they fall

Even though I’m not a Wall Street educated broker, making these gains is actually very simple. All I do is use the brokers’ own tricks against them.

But before I show you how you can beat the brokers at their own game, you need to understand how the deck is stacked against you. Let me illustrate this with a story about how PFSweb’s (PFSW:NASDAQ) IPO stole millions of dollars from naïve investors.

PFSweb’s IPO came in December 1999, at the height of the Internet frenzy. The company provided transaction services for traditional commerce and e-commerce companies.

But, honestly, what the company provided didn’t really matter. They could’ve sold cheese graters over the Internet. The word "e-commerce" was all brokers needed to get investors to snatch up shares at any price.

It all began with a media road show on Wall Street. PFSweb’s CEO gave his pitch to a room full of institutional investors. 61 Wall Street firms were able to snag IPO shares at US$17.00.

In the first day of trading, 50 of those 61 firms "flipped" their shares. And who could blame them? The share price skyrocketed to US$50 a share!

Over the next three months, hedge fund traders shorted the stock, driving it back down to US$18.00. And by January 2001, PFSweb was trading at a measly US$0.53.

PFSweb’s rise and fall was 100% orchestrated by Wall Street. And the thousands of individual investors who bought PFSweb on the first day of trading were burned… losing an estimated 70% of their money.

Now I want to tell you–I never buy an IPO on the first day it trades. Why? Easy. The first day is NOT in an IPO’s "profit zone."

That’s right. Unknown to most investors, there are two profit zones–periods of time in which you can make real money–in 78% of all IPOs. Play these profit zones correctly, and retail investors like you and me can reap huge gains.

Playing the game

I write about IPOs in Taipan. About companies that have a strong business model, good management, healthy balance sheets, etc. These are companies that will survive a market shakeout.

But for most individual investors, hot IPO shares are hard to come by. Brokers call you to sell them after they’ve already gone public, thus driving the stock price up. Then the brokers and institutions dump them, leaving the investor to fend for himself.

In PFSweb’s IPO, it was not the individual investors who were the big winners. It was the brokers, institutional investors and hedge fund mangers who made out like bandits.

Remember, a broker calls you to buy an IPO after its debut to drive the stock price up. Think about it. If an IPO was a hot sell, your broker will not be calling you. You would be calling him.

Like I said: if you knew how to play game, then you could make a mint.

Profit Zone One

There’s no doubt about it… in a bull market, IPOs are one of the best ways to generate explosive profits. New and exciting companies capture the fancy of institutional and retail investors alike. The ensuing frenzy pushes stock prices up 50%, 100%, even 1,000%, virtually overnight.

But, as we’ve seen, the IPO frenzy of 1999 and the first quarter of 2000 was short-lived. By the fourth quarter of 2000, new IPOs were nearly nonexistent. Investors began looking for value plays.

You yourself may have noticed that there is more than one way to profit from IPOs. These new kids on the block have a distinct pattern of profit cycles that stretches far beyond the initial honeymoon on the stock market.

For the first six months after an IPO, insiders are not allowed to dump their shares. And during this time, hedge fund managers and brokers are pumping the stock price up.

There are ways to ride this wave of wealth. Think about it. Investment bankers naturally try to pump their companies up. If the company performs poorly, investment bankers will have a harder time selling their underwriting services.

In effect, analysts help push the stock price up. But investors can get in and out and make a quick profit in the process. By looking at the institutional buying and selling, market conditions, volume, etc., I find the entry and exit points for a trade.

Last year I used this system to rack up double-digit gains in the aftermarket: Numerical Technologies, Inc. (NMTC:NASDAQ)–a 64% profit in three weeks; Rosetta Inpharmatics, Inc. (RSTA:NASDAQ)–a 94% profit in six weeks; and Sangamo BioSciences (SGMO:NASDAQ)–a 59% profit in just one week!

And remember: these were REAL aftermarket gains that investors just like you and me were able to take advantage of!

Even in this year’s dry IPO market, I was able to use this system to profit from Zone One.

We profited in this zone with trades like CoSine Communications, Inc. (COSN:NASDAQ)–a 39% profit in 3 days; OpNet Technologies, Inc. (OPNT:NASDAQ)–a 62% profit in 4 days; and Transmeta Corp. (TMTA:NASDAQ)–a 59% profit in 4 weeks!

Trading with the big boys

There are two key dates I look at when trading in Profit Zone One–the end of the quiet period and the lock-up expiration date.

The quiet period is 25 days after the IPO. During this time, companies and underwriters are forbidden by the SEC to release any information not found in the prospectus.

After the end of the quiet period, the investment bankers involved in the underwriting can release their biased analysis, pumping the stock price up.

During this time, I look for any unusual institutional trading. I look for "flipping" in the first week. I look for any increased buying in anticipation of the end of the quiet period.

Take a look at Rosetta Inpharmatics’ (RSTA:NASDAQ) chart. I issued a buy in ActionPoint Trader after noticing an increase in institutional buying.

That’s how we made a 94% profit in six weeks. One thing to remember: sell prior to the expiration of the lock-up period, which is 180 days after the IPO. Two months prior to the end of lock-up, investors sell in anticipation of insider selling.

Profit Zone Two

In Profit Zone Two, IPOs that debuted two to four years ago begin moving again. After two to four years, most of the flimsy, fly-by-night IPOs have been shaken out by the natural selection of market forces. Investment bankers are no longer interested.

What remain are the companies with a real future… and an additional margin of safety.

Let me illustrate Profit Zone Two with the IPO of XM Satellite Radio Holdings (XMSR:NASDAQ). XM Satellite debuted on October 4, 1999. The company owns one of two licenses issued by the FCC for satellite digital music services in the United States.

As you can see, XMSR had a momentum run in the first six months of its IPO. It didn’t really matter what the company did at this point. It was a technology company that offered a revolutionary service.

And that’s exactly how the investment bankers sold the deal. But, as you can see, the momentum did not last. The stock sold off in the fourth month in anticipation of the lock-up expiration.

And after two years, investment bankers lost interest. This is when XM Satellite came up on my Profit Zone Two radar screen. By now, XM Satellite was getting ready to launch its two satellites into space. The market was reacting.

More importantly, I noticed an increase in institutional buying. I issued a buy in ActionPoint Trader, and seven weeks later we sold it for a quick 141% profit.

I could go on and on about how traders have made money using the profit zones in the past. But it’s time to look ahead to more profits.

Market recovery

If there’s anything we’ve learned from the past, it’s that the market always recovers. The question everyone is trying to answer is "when?"

From the Korean War to Vietnam to the Gulf War, investors have reacted differently. But in each calamity, the market plunged only to recover to double-digit returns.

The time frame of the recovery is what varied. Let’s look at the market reaction to the attack on America thus far.

The Dow Jones Industrial Average plunged 14.26% after the attack on September 11. But a month later the DOW was trading at the same level as on September 10.

A month later the NASDAQ Composite Index was also trading at its pre-September 11 level.

All the signs indicate that things are beginning to recover. The IPO market is once again spitting out new deals. Principle Financial (PFG:NYSE) and Anthem (ATH:NYSE) raised US$1.85 billion and US$1.728 billion, respectively, in October 2001.

Eight IPOs debuted in October, raising a total of US$4.1079 billion–one of the busiest months in 2001. Not bad for a country that’s in crisis.

Deals will continue to get done, although at a slower pace than before. For the short term, the IPO market will react positively to any fiscal and monetary stimuli.

IPOs to watch

Eleven IPOs are expected to debut by the end of the year. There are currently four that stand out from the batch. U.S. insurance giant Prudential Financial is gearing up to price 110 million shares anywhere between US$25.00 to US$30.00.

This is a huge offering and probably a safe bet if you’re looking for modest gains. Prudential’s proposed ticker symbol is PRU.

The defense contractor United Defense Industries is looking to raise US$300 million in the public market. United Defense Industries has been manufacturing landing craft and tanks since WWII.

The company makes combat vehicles (the Bradley armored infantry vehicle), fire support (self-propelled howitzers), combat support vehicles, weapons delivery systems (missile launchers, artillery systems), and amphibious assault vehicles for the U.S. military (about 70% of sales) and its allies.

United Defense reported a net income in 2000. And with the war on terrorism, the company will receive much attention. I see this as a short-term play depending upon when the war ends.

You see, once the fighting stops, so will the demand for and awareness of the military defense companies. United Defense Industries’ proposed ticker symbol is UDI.

Screening and analyzing

Medical testing equipment supplier Bruker AXS is gearing up for a US$100 million IPO. The company makes X-ray systems that can analyze the structure of small molecules and aid in drug discovery and materials research. Bruker’s products assist pharmaceutical and biotech firms in studying protein structure abnormalities, the cause of many diseases.

In addition, chemical and raw material manufacturers use Bruker’s systems in researching materials for such products as steel, semiconductors, and plastics. Bruker’s proposed ticker symbol is BAXS.

Finally, a network security solutions provider, NetScreen Technologies, has filed to raise US$92 million. Netscreen is the only company on this list that has not recorded a profit. But with the increased fear of cyberterrorism and war, the company’s security hardware and software may be enough to generate public demand.

Its security systems and smaller appliances include firewall protection and network traffic management software. They range from systems designed for large Internet data centers to single-user units. Netscreen’s proposed ticker symbol is NSCN.

Remember, if you don’t get in on the IPO, there are different profit zones in the aftermarket. In Profit Zone One, look for insider and institutional buying and selling before deciding on your entry and exit points. Any companies that survive their first two years after the IPO then become candidates for Profit Zone Two.