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3 Steps to Vetting IPOs

Friday, 3 Sep 2010 | 7:28 PM ET
Anatomy of an IPO

Cramer on Friday dedicated a big piece of Mad Money to initial public offerings. Not only did he explain some of the more arcane mechanics of these deals, but he also offered three steps for deciding which IPO you should buy.

It’s all about the pedigree. Investors should research the managers, the investors and the underwriters. If any of these parties are suspect, then they should pass on the deal.

Believe it or not, but the managers might be the least important of the three. And that’s because so often the C-level suite can be relative unknowns, especially these days when tech companies are driven by their product and not the chief executive. Cramer had little doubt that Google’s twenty-something founders, Sergey Brin and Larry Page, would have seen far less interest in their IPO if it weren’t for their powerful search engine and a burgeoning online ad business. But they did have Eric Schmidt to balance them out, and he had a long and successful history in Silicon Valley.

Check number two, the investors, can end up being a major disqualifier, Cramer said, because he won’t recommend a company if he doesn’t like the people bringing it public. One of the biggest red flags is private equity. A lot of times KKR , Blackstone , Fortress Investment Groups and other PE firms use IPOs to dump less-than-stellar businesses on the open market. So, as a general rule, Cramer doesn’t trust them, and probably neither should you.

Lastly, there are the underwriters. You want to stick with household names in these cases, the Goldmans, Morgan Stanleys and Credit Suisses. Why? Because these firms have their reputations on the line with every deal they manage. Therefore, they are less likely to sell junk just to make money. Cramer said that once you know there’s no private equity behind a deal, one these underwriters can serve as a fairly good stamp of approval.

Now, that doesn’t mean that these underwriters offer winners all the time. But staying away from the smaller outfits, Cramer said, should help you avoid the losers.

Cramer still has one more lesson to teach you about IPOs: learning how to analyze the actual company that’s coming public. Click here so you don’t miss the final piece in the series.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

Questions, comments, suggestions for the Mad Money website? madcap@cnbc.com

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