Investing in IPOs – Cramer’s Strategy for Success

IPO Investing 101 with Cramer

Friday, 10 May 2013 | 6:40 PM ET

When deciding how to play an IPO, Mad Money host Jim Cramer asks 3 questions: what does the company do, who are its investors and which brokerage houses are bringing the deal?

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IPOs can be the most intriguing part of the market. And they can also be the most dangerous. If you're thinking about putting money to work in an IPO, Jim Cramer lays out what you absolutely must know before you can expect to make your first penny.

"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 bought dozens of companies in the last few years, in many cases paying far too much for them. They need badly to offload these companies into the open market so they can get them off the books. Some of them will be barely profitable, others will simply be stinkers that the brokers will try to entice you to pick up with the hope that a rising tide could lift all boats. The way I see it, these private equity IPOs, almost as a rule, cannot be trusted," 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.

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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 what the company makes, he determines if it's profitable, and most important he determines how big its end markets are.

Cramer said some of his favorites from 2012 include Annies, Five Below andGuidewire Software. these 3 cases, they passed all my tests," said Cramer.

Call Cramer: 1-800-743-CNBC

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