Be Careful Of Catching Facebook Fever

| About: Facebook (FB)

The world is ever changing, and Facebook is causing the globe to spin off its axis. This revolutionary application is one of the many new social media tools that helps people to connect with old friends and family, and share information without boundaries across the planet. Instead of waiting for the nightly news, people will check Facebook and Twitter accounts for any major breaking updates. You can find everything from new baby pics to Egyptian rebellion information. This phenomena, coupled with Facebook's 800+ million users and massive amounts of detailed demographic information, makes it a potential shining star in the investment arena.

Recently, Facebook applied for an Initial Public Offering, the process a company goes through to get permission to raise money from the general public. Facebook is expected to raise approximately $5 Billion through this offering. IPOs are very common occurrences; however, every once in a while, there's an IPO that gets everyone excited.

The media does in depth stories on the pros and cons on the company and the IPO. This is very good for a company, because it makes them more popular and in demand. Just like in high school, the more popular you are, the better your chances of getting a pretty prom date. For this example, the pretty prom date is plenty of investors interested in buying shares of your company's stock.

However, IPOs typically don't work to the advantage of the average everyday Investor, since shares are sold to the big banks and pension plans, before they go to Joe Q Public. Unfortunately, once these shares prices are pumped up, they tend to fall in price, and create losing investments for their original investors.

Tim Carmody and Mike Isaac of Wired magazine reported that "Facebook's IPO will meet a fate similar to that of this year's other high-profile tech IPOs." Some of these high-profile IPOs were Groupon (NASDAQ:GRPN), Linkedin (NYSE:LNKD), General Motors (NYSE:GM), Yelp (NYSE:YELP), Michael Kors (NYSE:KORS) and Pandora (NYSE:P), which all debuted within the last 12 months. I found that these high-flying IPOs tend to lose money for their investors.

Below is a table of the most famous IPOs that have come to market since 2011. Out of the 6 super famous IPOs that we examined, only one made money for its investors - Michael Kors.

General Motors Linkedin Yelp Michael Kors Groupon Pandora
11/18/2011 5/19/2011 3/2/2012 12/15/2011 11/4/2011 6/15/2011
34.19 94.25 24.58 24.2 26.11 17.42
3/9/2012 3/9/2012 3/9/2012 3/9/2012 3/9/2012 3/9/2012
25.62 90.13 19.8 49.59 17.06 11.5
-25.07% -4.37% -19.45% 104.92% -34.66% -33.98%

If you look at the best performing stock, Michael Kors, with a 100%-plus return, versus the worst performing company, Groupon, with a -34.66% return, they tell two different stories. But why is KORS doing so much better then GRPN? To explain that, you must understand that the stock market likes companies that make money and have the ability to continue to make money in the future. After digging through the numbers, you will find that Michael Kors had sales of $373 mil, and put $39 mil in profits in the bank. On the other hand, Groupon had sales of $506 mil and lost $ 42.7 mil. So basically, you have one company that is making money and the other that is losing money; that is one of the major reasons why the two stocks have performed differently.

If you would have invested $10k in Michael Kors, you would have turned it into $20k over the span of four months. If you invested $10k into Groupon, you would only have $6,534 left after four months.

In Facebook's case, they actually make money. In their IPO registration, Facebook reported that they generated revenue of $3.7 Billion and $1 Billion in net income. According to, a site dedicated to the buying and selling of non-public stock, the current value of Facebook is approximately $95 Billion. A common way to determine if the value of a company is too expensive or too cheap is too divide the current company value, which is $95B, by the company's revenue, which is $3.7B. The result of this calculation is 25.7, So Facebook is roughly worth 25.67 times its revenue.

This 25.67 figure is also called a multiple. Often times, stock analysts will compare different companies' revenue multiples to see if they are paying a fair price. If you were to look at Apple's revenue, which is $108B annually and their current company value of $508B, you have a revenue multiple of 4.7. So Apple is roughly worth 4.7 times its revenue. Facebook's 25.7 vs. Apples 4.7, illustrates that, Facebook stock is more expensive then Apple stock.

  • Now that you have this information, the magic questions are:
  • Do you think Facebook is a better company then Apple?
  • Do you think Facebook will make more money than Apple?
  • Do you think Facebook is a fair price?
  • Do you think they can continue can to make money?
  • How can you justify paying such an expensive for a company?

In conclusion, if Facebook follows the same pattern of the these high profile IPOs, its stock price will jump up on the first day of trading and then fall, creating a loss for its retail investors that buy that day. What are the chances history will repeat itself?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.