Yelp: Determining IPO Trends For Large Gains

 |  About: Yelp (YELP), Includes: GRPN, LNKD, RENN, ZNGA
by: Brian Nichols

Most likely, if you were one of the many who placed a buy order for Yelp (NYSE:YELP) at the open on Friday then you lost money. The stock opened at $22.01 but was then $24.65 in a blink of an eye. The stock then reached $26 before retracing to trade at a fairly consistent level for most of the day. The stock does trade with an attractable market cap (considering other social networking companies) and has significantly increased revenue year-over-year but is also seeing a decrease in margins. Therefore, it has positives and negatives but still a large amount of uncertainty.

It's way too early in the company's existence to know if Yelp would make a good investment, therefore I am not going to make a recommendation or prediction one way or the other. I think it has a strong platform and a possibility to succeed, but with all these social networking companies it's beginning to feel a bit like the dotcom era. I currently do not own any of the social networking companies, however I do play several of the IPOs with a trend that I have identified that returns a significant amount on an investment. And I believe that Yelp will almost certainly follow the same trend.

I have followed nearly all of the high profile internet based company IPO's over the last year; and all but one follow a very distinct pattern. They have all traded significantly higher at open but are then followed by a downward trend. But what's interesting is that each and every stock that follows this trend reverses to post gains near 50% in a short period of time.

On November 29 I wrote and published an article "Groupon Following The Trend Of Past IPOs" in which I identified, called, and explained this trend. During the 10 days that followed this article, Groupon (NASDAQ:GRPN) returned a 54% gain, and successfully executed this trend. However, GRPN is not the only stock that has followed this trend. Below is a list of five notable IPOs during the last year that were deemed "high-profile" that followed this trend. The first set of percentages are the margin at which the stock fell from its high and the second set is the margin at which the stock increased after the fall.

Company Ticker % Fall % Rise
Renren (RENN) 70% 73%
Linkedin (LNKD) 50% 75%
Pandora (P) 50% 50%
Zillow (Z) 60% 55%
Angie's List (ANGI) 40% 44%
Click to enlarge

Each and every one of the companies above is different and has very few similarities with the others. However, the one similarity that every stock shares is that each posted large gains the day of its IPO, then fell shortly after, and posted large gains from its low. Unfortunately, there is no standard for when this trend will take place, but it always occurs within the first few months of the stock's IPO. As a rule of thumb, I always wait for the stock to decline 40% from its high and then I wait for one day of gains before purchasing the stock, which means the trend wouldn't occur until YELP reaches a price around $15, possibly $13.

People often ask why this trend occurs, and my response is usually "I don't know." There is no specific reason for this trend to occur but as an investor who places a large emphasis on behavioral finance I do have a theory. I believe the reason that the stock posts such massive gains when it begins trading is because investors want to buy a highly anticipated stock that has received a large amount of coverage by the media, and because they believe that stocks return the best gains on the day of its IPO. I think the stock then falls as a domino effect.

Unfortunately, investors never have the opportunity to buy the stock at its IPO price, and are forced to buy at the open price, which could be 40-60% above its IPO. As a result, when the momentum begins to fall and investors take profits the domino effect is initiated and investors sell to limit loss from the high premium they were forced to pay. Finally, once the stock reaches a price that investors perceive as a value then another domino effect begins and those who first bought because of the optimism are dragged back into momentum of the stock. Of course this is speculative, and lacks fundamental analysis, but it's my personal belief of why these high profile speculative stocks follow this trend.

As I said, there has only been one occasion when this trend was unsuccessful, and it was with Zynga (NASDAQ:ZNGA). Prior to Zynga's IPO I wrote an article in which I called the same trend for ZNGA. But for some reason, ZNGA did not follow the same trend, most likely because it was the first of these IPOs to trade lower during its IPO. Therefore, since it never traded higher on its IPO it doesn't count for this particular strategy, but it's still considered a stock in this category of companies.

I will conclude by saying that I have only found this trend in a certain class of stocks: high profile internet based companies or social media. It does not work on companies such as Michael Kors (NYSE:KORS), probably because there is less uncertainty surrounding companies with established locations that are not primarily operated through the internet. I can't tell you exactly when this trend will occur, and this stock may be the first to pop on its IPO but not follow the trend. But as an investor, be on the lookout, and if the stock begins to fall and it reaches a price that is 40% off its high, then wait for one day of gains, and ride it higher to a quick 40-50% return.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.