IPOs Gone Wild

Editor's note: A previous version of this article incorrectly stated that VA Software is a penny stock. We regret the error.

Buy, sell, flip it now. These are the words that run through a day trader's mind when a company comes to the market for the first time. The IPO hype machine has been gaining speed at a frenetic pace. Investing in the IPOs of companies like Chipotle Mexican Grill (NYSE:CMG) and Traffic.com (NASDAQ:TRFC) has been all the rage. According to Renaissance Capital, this past January, the market had 11 new public offerings that raised a total of $1.8 billion. At the peak of the tech bubble in early 2001, one month brought in 17 offerings raising $3.1 billion. Based on those statistics, it seems like we're riding a fast wave to the top all over again. But does all this smoke and glitter make for a good investment strategy?

What makes a great IPO?
IPO success should be defined by how much the company has returned over a long-term investment horizon, but it's usually defined by how much it "pops" the first day. Some of the biggest standouts in IPO history have been Akamai Technologies (NASDAQ:AKAM), Sycamore Networks (NASDAQ:SCMR), Priceline.com (NASDAQ:PCLN), and Baidu.com (NASDAQ:BIDU) -- each of which popped more than 300% on the first day.

But are the biggest one-day winners also the biggest long-term winners? The above group has returned an average of negative 81.6% since their respective IPO dates. And even in the midst of those "winners" that popped on the first day, there's still a list of bankruptcy candidates and penny stocks like Theglobe.com. It's also interesting to note that all of these, with the exception of Baidu.com, went public right around the tech bubble, so it's debatable how much value was actually intrinsic to the companies themselves instead of the perception of value created by an overly exuberant market.

In fact, many studies show that the best long-performing IPOs have been companies that only had a minimal pop on the first day -- less than 20%. That was how much Google gained on the first day, but since its IPO, it has returned almost 330%.

Don't buy the hype, buy the stock
Take a look at the chart below. You can see that the most recent IPOs have returned a negative 1.58%. But if you had waited until the IPO hype died down, you could have had a return of 13%.

If you'd done your due diligence and stuck with the companies that proved to have the best long-term business models, you could have made even more. That's some pretty heady profit incentive to invest in a newly public company, especially if you can wait for a drop before buying.

How you can invest in the hot stuff
IPOs are mostly the stuff of hype and glamour, and all this hype throws up a smoke screen that makes it easy to pay too high a price. Waiting after an IPO to get a better price usually works out for the best in a portfolio of stocks. And even if you get a nice pop on the first day, there's absolutely no guarantee that your company will even be around in a few years.

But if you're the kind of investor who favors the hot new thing, you might be interested in taking a free guest pass to the Motley Fool Rule Breakers newsletter service. Instead of just buying the next hot new thing, Rule Breakers is focused on finding proven businesses that innovate and disrupt the traditional. For example, when the newsletter singled out Blue Nile (NASDAQ:NILE) six months after its IPO, Fool co-founder David Gardner noted Blue Nile's increasing market share, attractive growth rates, and supply-chain management as reasons for his recommendation. And even though Akamai is a recommendation, it was recommended at a much lower price than the IPO, and after its business model was shown to be viable; it has since returned 150%. This strategy has worked well so far -- Rule Breakers as a whole is beating the market by 20%. Those types of returns seem worth a hot stock tip or two. So forgo your hyped-up investing style, and take a free 30-day guest pass instead to see what other growth is in store.

Blue Nile and Akamai are Rule Breakers recommendations. Priceline.com is a Stock Advisor pick.

Fool research analyst Shruti Basavaraj owns no shares of any company mentioned above. The Fool's disclosure policy is ironclad.