The only thing better than buying into a great company is doing so early in its growth cycle. Initial public offerings (IPOs) are the first sale of a company's shares to the public. They give investors like you and me a shot at an early arrival -- but it's never quite as easy as that.

Many ground-floor opportunities promptly sink into the basement. Some "can't-miss" and "lay-up" IPOs wind up as nothing more than airballs.

You can help your cause by learning to spot the differences between the winners and the losers. What makes a hot IPO great? What are the warning signs of a debutante stinker? Let's dive into the answers you need.

Anatomy of a hot new stock
The best way to unlock the secrets of tomorrow's big gainers is to dig into the market-thumpers of the past. Let's take a closer look at some of the best-performing IPOs to hit the market over the past year:

Company

IPO

Gain

American Public Education (NASDAQ:APEI)

$20.00

135%

Titan Machinery (NASDAQ:TITN)

$8.50

88%

CardioNet (NASDAQ:BEAT)

$18.00

35%

Visa (NYSE:V)

$44.00

34%

K12 (NYSE:LRN)

$18.00

29%

Source: Renaissance Capital IPO Home.

Don't wrack your brain looking for a common theme. The winners come from all walks of life. Yes, American Public Education and K12 are both education service companies. However, Titan Machinery is a dealer of agricultural equipment to farmers. CardioNet is a Medical Instruments company.

In short, you are unlikely to see all five of these companies rubbing shoulders at any particular industry trade show.

So what ties all of these hot issues together? It isn't necessarily pent-up market demand. CardioNet closed below its $18 IPO price on its first trading day. Redemption came as investors gradually flocked to the shares.

Sometimes a hot IPO shows its winning ways right away, of course. That's what happened to Visa. The stock opened at $59.50, well above its $44 IPO price tag.

Lumber Liquidators (NYSE: LL) has enjoyed an even wilder run. The leading retailer of discounted hardwood flooring went public at $11 in November. Two months later, it bottomed out at $6.07, with investors fearing that the moribund housing market would chop up the chain. It didn't. Lumber Liquidators recovered, and shares have recently rebounded back to $11.

Brands like American Public Education and Titan, along with investing themes like education and farming, will provide an early advantage, but these success stories wind up earning the market's faith by producing strong quarterly results early in their tenure.

So what have we learned? Hot IPOs come from different sectors, and they're saddled with different investor expectations. Will that help you land the winners from now on? It will if you accept the nuances behind the disparity. Most of the hotties came to market as quality players, then went on to cement that perception with heady quarterly growth performances.

The pitfalls of IPO investing
There are naturally plenty of dogs in any IPO litter, even if the themes make sense. Xinyuan Real Estate (NYSE:XIN) went public in December at $14 a share. Can't miss, right? China and real estate should be as explosive as Diet Coke and Mentos. But it certainly hasn't panned out that way; Xinyuan kicked off this trading week at $2.12, nearly 85% below its IPO price.

Internet Brands is another gravity victim. The company runs high-traffic Internet sites dedicated to lucrative areas like travel and auto research. Internet and valuable keywords would have been a potent combination a couple of years ago, but they haven't panned out so well for Internet Brands. At $8 a share, it's trading below November's IPO .

We like to weed out the potential portfolio-killers by looking for a few warning signs.

  • Is the IPO an exit strategy? If there are too many executive insiders selling, it may be.
  • Is this an inferior company trying to ride coattails? Many investors learned this the hard way in the dot-com bubble days, when pretenders like Pets.com and Webvan collapsed. Make sure that new stocks are as good as -- if not better than -- their publicly traded peers.
  • Is the valuation realistic? Underwriters often reach too high for a company, when the prospects are much lower.
  • Is it a forced IPO? We hate it when a company rushes to go public as niche enthusiasm is waning. It's as if they've heard the last-call order from the bartender and are scrambling to order one more beer. Whether it's a nervous private equity firm or a cash-strapped upstart, it's a good bet to avoid those "me too" companies like the plague.

So, where does that leave you? The IPO pipeline is never dry. There may be fewer new issues going public while the market corrects itself, but quality ones find a way to earn their ticker symbols.

Getting in early has its risks, of course. We've already explored how that ground-floor elevator sometimes stops down in the basement. However, getting in early is the best way to enjoy the longest ride up to the penthouse.

Motley Fool co-founder and Chief Rule Breaker David Gardner is leading a team of Fools to Silicon Valley in search of the next great high-growth investing success stories. To get their trip dispatches and their exclusive analysis from meetings with top executives, sign up now for a free 30-day trial of the Rule Breakers premium stock-research service.

Prashant Rathore updated this article, originally written by Rick Munarriz and published on March 10, 2007. Prashant does not have any financial interest in the companies mentioned above The Fool has a disclosure policy.