Should you get in on the IPOs?

One of the most difficult areas of investment is one of growing prominence in 2011 - initial public offerings - otherwise known as IPOs.

Pandora (NYSE: P), Groupon, LinkedIn LNKD, Zynga and social media behemoth Facebook are just a few of the IPOs for 2011.

While I love the idea of new companies coming to market - vastly expanding our universe of profitable opportunities - I still remain skeptical of the average investor leaping into IPOs.

Don't get me wrong - I am definitely a believer in IPOs. Without them, Microsoft MSFT, Google GOOG, Apple (Nasdaq: AAPL), and thousands of other blue chip companies would not be the tech giants they are today. IPOs are the very foundation of our investing system.

But the hypester promoters - and the gullible investing public - gave IPOs a black eye in the late 90's, early 2000's - and with some of the new and recent IPOs coming downstream, it looks like they have not completely disappeared.

Take Renren RENN, for example. The Chinese social networking company has never been profitable. Yet its 2011 IPO was hyped to the gills, raising $743 million, with the shares debuting at $19.50. Currently, those same shares are trading at roughly $7.50.

This is a perfect example of when the buyer should beware. As the IPO market heats up, investors will have to be very careful in avoiding buying shares in those companies that have no business selling stock to the public - businesses with no profits and esoteric products that I couldn't explain to my smartest friends, let alone my grandparents.

Let me back up a minute and tell you what IPOs are supposed to be and do.

Successful entrepreneurs often find that the needs of their businesses have outgrown their personal financial assets. Consequently, if they want to remain competitive in their industry, they must expand. Or they die. Therefore, the number one driving force behind IPOs actually is to raise capital to expand a business.

Yep, that's right. The stock market was and is meant to be an exchange of cash for stock, with a long-range plan. Investors turn their hard-earned cash over to well-run businesses who want to grow. In return, investors hope to get their money back, plus a profit - over a period of time. Not overnight.

Unfortunately, it's not only novice and greedy investors who may be taken aback by that statement. Why? Because Wall Street has conned unwitting investors, millions of decent people, into buying into their theory that IPOs are a get-rich-quick-scheme - for the lucky few.

They couldn't be more wrong. Except, of course, that for Wall Street execs, their largest clients and even some politicians, it does usually work out that way. But for everyday people - the bulk of investors in this country - the story is not quite so sweet. In fact, I can count on one hand the number of individual investors that I personally know who have made a killing in the IPO market. And just a few more were actually able to get their hands on IPO stock at the offering. And I bet you can say the same thing.

So, forget about easy money. Instead, think about investing in companies that make a real product, that have the potential to grow their businesses with double-digit returns - in the foreseeable future.

And forget about getting into an IPO when the company first becomes publicly-traded. Unless you are a well-heeled big brokerage client, or someone with political connections, the only IPOs you are going to be invited to buy will be dogs. Take my word for it.

But that's not to say that you can't profit from IPOs. Just let the companies go public, and then bide your time. Be selective, look at the numbers, and see if their product makes sense. After the first couple of public quarterly reports, take a close look at the companies, evaluate them from the standpoint of how well they will fit into your personal investing strategy and portfolio, and then buy the ones that look to have favorable, long-term potential.