How to Profit From an IPO Even When You Can't Buy the IPO

Surfers sharing a wave. Lagundri Bay, Nias, Sumatra, Indonesia, Southeast Asia, Asia

Shares of an initial public offering in a hot company are practically the holy grail for most investors. The opportunity to get into a stock on the ground floor before the general public has an opportunity to buy in can be a fast way to make a profit. Unfortunately, IPO shares are usually allotted only to large investment firms or their select high-net-worth clients.

There is, however, a way in which you can still ride the wave of a highly anticipated IPO in order to make some money.

When it comes to investing, much of Wall Street has a herd mentality. Just as different TV networks look to the most popular shows on rival networks, then try to produce more shows in the hot genres, investment managers who see a company doing well will look for other companies in that sector to invest in. For example, if Facebook is hot, investment money will flow into other social media companies like Twitter or LinkedIn, and in the process drive all their share prices higher.

This effect isn't limited to public companies; it also exists between companies in the same sector, even if some are public and others are private. A strategy that takes advantage of this can often give you an edge in your investing.

%VIRTUAL-WSSCourseInline-538%Take for instance HomeAway, which trades under the ticker symbol AWAY. HomeAway connects landlords and renters, helping to facilitate short-term vacation rentals in the United States and internationally. Fundamentally, it's a sound company riding a growing tech trend, with rising EPS and revenue estimates, as well as a history of beating analysts' expectations. These factors alone would make it a worthy candidate to consider investing in, but if you dig a little bit more, you'll find another potential ace-in-the-hole.

That ace is called Airbnb.

%VIRTUAL-article-sponsoredlinks%Airbnb is the premier company in the online rental game -- the same sector that HomeAway occupies -- but it's a private company. You can't invest in it yet. However, it's expected that Airbnb will launch an IPO late in 2014, with a valuation of over $10 billion.

Here's where that herd mentality comes into play. As investors' attention is drawn to a hot IPO, capital tends to flow to its publicly traded competitors; in essence, they become a proxy for the better private company. So even though Airbnb may be the better of these two companies, HomeAway's stock should still go up as anticipation of Airbnb's IPO rises.

Of course, there are no guarantees, and what happens in the overall market will probably play a bigger role in HomeAway's share performance than the Airbnb IPO. But now that you know how this symbiotic relationship works, you can use it find other examples -- and profit from them as well.

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Originally published