The debacle of Facebook's initial public offering should make anyone leery of jumping into an IPO, if they weren't already skeptical about them.
But it begs the question of whether one should invest in the social networking site that has revolutionized how people communicate with each other.
The much-anticipated IPO, which offered 421 million shares at $38 and valued Facebook at more than $100 billion, was the subject of incredible hype beforehand and an emotional backlash afterwards as the price plummeted nearly 20% in the first few days of trading.
Analysts branded it a "broken IPO" and one compared the stock to a "falling knife" that no one wanted to grab.
MarketWatch commentator Chuck Jaffe scolded anyone who believed the hype by labeling the IPO "the stupid investment of the week," and said that the experience should teach investors once and for all that the letters IPO really stand for "it's probably overpriced."
Subsequent trading seemed to drive that point home as Facebook shares continued to dive, declining more than 30% from the IPO price of $38. The head of Morgan Stanley, which was the lead manager on the share sale, said investors were "naive" if they thought they would profit on the first day of trading.
Inspired by Other Tech Stock Winners
But optimists had visions of another Google dancing in their heads, which saw its share price double in the first few months of trading and quintuple within 2 years (though it has oscillated around $600 since then, with occasional bigger dips).
Apple, whose share price has risen steadily over the past 5 years, quintupling in value, probably ranks as the most successful big tech share. Apple, however, makes things that people buy -- iPhones, iPads, laptops, PCs -- and also makes a ton of money raking off part of the proceeds from content that gets sold to people using these devices.
Facebook, and Google for that matter, have more intangible assets -- hundreds of millions of Internet users who leave behind useful traces about what they're interested in buying.
Google, though, has proven that it knows how to deliver advertising messages to people who are interested in them, while Facebook has yet to figure out just how to insert commercials into the social networking experience.
General Motors drove home that point with the announcement just before Facebook's IPO that it was pulling its advertising from the site because it had seen no measurable return on that investment.
Facebook is nonetheless the 800-pound gorilla in a social networking phenomenon that has swept the globe. And while many still think it is just a passing fad, you'd have a hard time convincing anyone under 30 that such networking is not a permanent fixture in their lives.
Why You Should or Shouldn't Snap Up the Stock
For now, it seems likely that Facebook stock will be buffeted by high-frequency traders looking for quick profits in a volatile issue. More shares will be hitting the market in coming months as IPO lockups expire, so that it will be some time before a reliable price picture emerges. Some analysts see a chance of the stock going as low as $10, while others are tipping $44 in the short term.
Obviously nobody knows. Every investor has to make his or her own decision, and you will probably want to consult with your financial advisor in figuring it out for yourself. But answering the question of whether you should invest in Facebook makes for an interesting case study in which to review some tried-and-true rules on investing.
1. Don't invest in IPOs
Jaffe is right. Pricing IPOs has always involved balancing the desire of the sellers (the founders and investors who got the new company off the ground) for the highest possible price and the preference of the buyers (institutions and individuals) for the price that will allow the greatest chance for future gains. That balance has tilted decidedly in favor of the sellers in recent years, and many analysts are saying that Facebook's $38 IPO price was too high and will make it difficult for other tech companies to go public.
Although some institutional investors may feel it is necessary to get in on the ground floor with a stock that could become a must-own issue, there's very little reason for retail investors to feel that way.
There was a time when a stock that sold for $38 might never look back and you wouldn't have a chance to get it below $50 or $75. But that hasn't happened in a while, and your chances of getting lucky on one of those issues are not great.
In this case, you would have been better off waiting a day or two and picking up the stock for $31 -- if you think it's a good investment.
2. Invest in what you know
It would almost certainly be foolish to invest in Facebook unless you were an active user on the network or could talk to friends, children, or grandchildren who are. Facebook's main asset is its 900 million active users, so it's very important to have a feel for what they're thinking to understand the future of the company.
Rupert Murdoch's News Corp. missed the boat when it acquired MySpace, an early Facebook rival and the market leader at the time, for $580 million in 2005 only to sell it just 6 years later for $35 million after MySpace lost out to Facebook.
Analysts say that Facebook users -- the college generation that first embraced it a decade ago -- are already "aging" and that younger people today have numerous alternatives, such as Twitter, Pinterest, and Flickr, among others. Will members continue to use Facebook as faithfully as they have done, or will the switch from PCs to mobile phones as the main communication device favor some of these other formats?
Facebook has had some difficulty making the transition to smart phones, and the company's purchase of the photo-sharing service Instagram for $1 billion this spring was designed to help close that gap.
In a case like Facebook, your view of the company's future will depend a lot on what you think of Mark Zuckerberg, the young man who founded it and masterminded its rise as the premier social networking site. Can Zuckerberg continue to reinvent Facebook in a fast-moving tech environment in the way that Steve Jobs kept reinventing Apple? Reports out just this week say that Facebook is getting serious about developing its own smart phone and may spend another $1 billion buying the Norwegian developer of a versatile browser.
Other Important Considerations
3. Limit your exposure
Where does an investment in Facebook fit into your portfolio? Is it a purely speculative stock or do you see it as a key component of a 21st century portfolio? What is your timeframe? Do you want to see a strong gain and early exit or is this a buy-and-hold stock?
Because Facebook is not only a new company but basically a whole new industry -- social networking -- it is difficult to evaluate its performance so far or to make any forecasts. There is no track record or benchmark for this industry.
The phenomenon of social networking could vanish as quickly as it appeared, or Facebook could begin to look like a dinosaur as newer, nimbler rivals appear on the scene. For that reason, you have to be ready to lose your entire stake in Facebook or set a strict limit for selling if it reaches the price marking how much you're willing to lose. "Strict" means that you really sell at that price and don't fall into the retail investor's trap of holding out for the stock to come back.
If you go into the stock for a relatively quick gain, set a deadline depending on the timeframe for this investment. Is "quick" 1 year or 5 years? You could have sold Google after 2 years, for instance, and booked the same gains as if you had held it and sold now.
4. What is your opportunity cost?
If you invest in Facebook now, will it make more money for you than other investments would? Value investors look for stocks that are undervalued. A lot of people concluded that Facebook was overvalued when it plummeted in the first few days of trading, but some analysts felt that it was undervalued at the IPO price of $38 and really undervalued at $31.
Facebook has no track record, so it might be easier to identify other stocks as undervalued based on their performance. David Rolfe of the RiverPark/Wedgewood Fund suggested at the time of the Facebook IPO that investors would be better off putting their money into proven stocks such as Warren Buffett's Berkshire Hathaway and Apple, which seem to be undervalued now based on their past performance.
5. Know what you're looking for in an investment
Some retail investors are abandoning the stock market, which they see as a casino rigged in favor of the house. The Facebook IPO seems to be a poster child for everything that's wrong with Wall Street now -- institutional investors getting better information, technology favoring the big investors over small investors, greed overcoming fairness.
But the very size of the company and of the initial float of more than 400 million shares should make Facebook less volatile once the waves from the IPO finally subside. In other words, if Facebook has a future, buying shares is probably a good way to benefit from it, regardless of the IPO glitches.
Many investors would prefer to hit a home run with a great stock pick than play the small ball of eking out gains through a well-balanced mutual fund. But that can lead to a lot of attempts and failures. Are you in a position now in your career or your retirement planning that you can afford to take a big loss if it means you could potentially have a huge win? If so, maybe you will want to step up to the plate and take a swing.
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