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Investing in IPOs – Cramer’s secrets for success

(Click for video linked to a searchable transcript of this Mad Money segment)

IPOs can be the most intriguing part of the market. But if you don't know what you're doing, they can also be the most dangerous. With the IPO's of Noodles & Company, Gigamon, ChannelAdvisor and others grabbing headlines, Cramer thought this would be a good time to lay out what you absolutely must know about a company before buying its initial public offering.

"The first and most important thing I look for with an IPO is the company's pedigree," Cramer said. "Who are the executives?"

Sometimes that can be a difficult question to answer. "Back when Google went public you probably would have avoided its IPO like the plague. I mean think about it, who the heck were Larry Page and Sergey Brin?" This is a case where doing due diligence and learning about the leadership is critically important.

Adam Jeffery | CNBC

In addition Cramer also examines who benefits from the IPO.

"Private equity firms, like Blackstone, KKR, Thomas Lee, Carlyle, and Cerberus, have all bought dozens of companies in the last few years. Sometimes the purchase was shrewd but other times they overpaid badly. In the latter case, they need to offload these companies into the open market so they can get them off the books. Therefore, at best, these private equity IPOs, almost as a rule, are difficult," Cramer said.

Cramer also notes the financial firms involved in the IPO

"I want them to be major firms along the lines of Goldman Sachs, Morgan Stanley or Credit Suisse or JPMorgan. Why does that matter? Because these firms have their reputation on the line with each deal, and that makes them less willing to bring a klunkler public just for the fees. I consider the brokerage that's underwriting the deal as a fairly good seal of approval for the enterprise."

Only if a company passes this three pronged test will Cramer's continue to determine if the company is in fact investable.

Make no mistake, "Just because it's met the criteria above doesn't mean it isn't terrible," he said. "It could still be a piece of junk."

From this point Cramer assesses the size of the market, the power of the competitors, and then he determines how the company that's coming public is valued versus similar players.

Then he looks at other metrics he talks about all the time on Mad Money; metrics such as growth potential, margins, fixed and variable costs and, of course, debt.

"Only if an IPO meets all my criteria do I ever put in for the deal," Cramer said. "It must all be favorable."

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What's the bottom line?

When Cramer analyzes an IPO, he begins with pedigree. That is he asks himself who are the executives? Then he examines who benefits from the IPO and the financial firms involved in the deal. If the IPO can pass that 3 pronged test, he then determines the addressable market, the competitors, and the historic growth rate of the company versus the growth rate of the market itself.

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