What Wall Street Is Selling

The market for initial public offerings (IPOs) is one I like to watch. Not because I like to buy IPOs, but because what�s hot in the IPO market can give you some clues about what you might not want to buy.

I wrote to my Capital and Crisis readers a couple of weeks ago about Silver Bay Realty, a company dedicated to managing a portfolio of single-family rental homes. It was the first IPO of its kind when it debuted in December. I panned it. But what�s interesting here is there are more Silver Bays in the hopper.

At a recent conference in Las Vegas, Waypoint Homes CEO Gary Beasley said he expects more IPOs of single-family landlords. According to Beasley, there are five-six companies with at least $500 million in assets, including three with at least $1 billion.

So there are several private equity firms that spent the last few years putting together portfolios of single-family homes. Now they are ready to sell them to investors like you.

Buyer beware.

Wall Street serves up whatever it thinks it can sell. What sells now? Ironically, housing stocks sell well. As reviled as they once were, now investors love the idea of a housing recovery. So homebuilder stocks are another example of what�s selling well now.

Not too surprising, because investors tend to chase performance. Homebuilder stocks had a great 2012. PulteGroup Inc., for example, was one of the best performing stocks in the S&P 500 last year, as it nearly tripled. The SPDR Homebuilders Index rose 55% in 2012. So now investors say, �Gimme more!�

Wall Street happily obliges. Now there�s a little boom forming in housing-related IPOs. Taylor Morrison Home Corp. and TRI Pointe Homes Inc. have both filed for IPOs. These are the first homebuilder IPOs since 2004. This follows builders such as Meritage, Beazer Homes and Standard Pacific selling almost $450 million worth of stock in 2012.

Investors want to play the housing recovery, and you can be sure Wall Street will create lots of ways to do that. Just be careful, as they are likely not as good for you as they are for their promoters.

Another area to be careful about is high-yield stocks. With interest rates so low, investors are starved for income on their savings. Hence, the boomlet in IPOs from stocks that pay generous dividends or distribute profits to shareholders, such as master limited partnerships (MLPs). These stocks pay high yields, on average around 6%, which is a lot better than what you can get in a savings account. (They come with lots of extra risk compared with a savings account, too.)

Investors can�t get enough of them, and Wall Street is cooking up new ones. Last year, there were 14 IPOs from MLPs. According to Dealogic, this was the most MLPs raised since 2009. So far in early 2013, it looks like more of the same, with three more already. USA Compression Partners went public, and CVR Refining and SunCoke Energy are in the wings. They will all raise or have raised hundreds of millions of dollars by selling stock in an IPO.

My main point here that I want you to remember is this: An initial public offering is basically a stock that insiders want to sell. It�s a business they don�t want to keep for themselves anymore. If you always remember this, you�ll forever look at an IPO with the proper amount of skepticism. If it is such a great thing, why are they are letting you in on the deal?

Stocks � like stars � are born nearly every day. Yet there is an inner logic that drives the process.

It helps to think about the stock market as just one of the markets for companies. There is also a private market. In other words, there are private companies that get bought and sold too. You don�t see these reported in the stock tables, but they are just as real.

When stock market prices are higher than what is available in the private market, you�ll see lots of IPOs as private investors sell to the public to reap that windfall. When stock market valuations are lower than those of private markets, you�ll see more companies go private as insiders buy them and take them off the exchange.

With this framework in mind, you can see how the many new IPOs in high-yield stocks and housing stocks are likely a sign of a pricey stock market for these assets � not necessarily a sign of good investments on offer.

Of course, there are legitimate reasons for a company to go public. It�s just when we see a spate of similar companies going public at the same time that you should cast a doubtful gaze. And not all IPOs are terrible investments. Investors who bought Google at the IPO are pretty happy today. Still, the odds are against you. Googles don�t happen very often. Most of the time, you are better off avoiding the hot-selling IPOs that Wall Street is serving up.

Put another way, I�d rather align myself with insiders who are buying than those who are selling.