A Cautionary Strategy For Those Looking To Invest In Facebook

May.24.12 | About: Facebook (FB)

As one the people who read through the entire initial filing of Facebook (NASDAQ:FB), I couldn't have written the script any better. Friday's trading session opened flat, and Wall Street can blame all the technical indicators it wants, the result, no matter how it happened, would have still remained the same. Many investors wanted to see a similar reaction to how Google (NASDAQ:GOOG) performed on its first day, except for the fact that those of us who read the numbers knew it wasn't going to happen. I strongly believe trading social media needs its own unique strategy. When it comes to Facebook, investors need be a bit cautious before putting all their eggs in one basket.

When Facebook continued its demonstrative slide by the close of Tuesday's trading, retail Investors were left wondering why this was happening. The answer is two-fold. First, very few people actually read the fine print about the revenue and EPS the company disclosed in its S-1. Second, the lead underwriters in the filing, Morgan Stanley (NYSE:MS) as noted by the Wall Street Journal, failed to properly disclose the risk to all of its retail clients. One of Morgan Stanley's analysts actually estimates that Facebook's revenue will be much lower than originally anticipated. Those two catalysts have driven, and will continue to drive the stock down until Facebook announces its first quarterly report sometime in either late July or early August. Analysts are expecting Facebook to earn $0.13/share on $1.18 billion dollars in revenue.

Investors should actually wait a bit before establishing a position in Facebook, as it is way too early to fully navigate the direction of not only the stock but the company as well. Even though upside potential is certainly existent in the company's future, downside potential is going to be more prevalent in the short term.

There are two risks involved with establishing an immediate position. The first risk lies within company valuation, in the first three days of trading Facebook has lost nearly $37 billion dollars in market capitalization, which leads me to believe the $34-$38/share price target was completely over-hyped. The second risk comes in the form of investor confidence. For example, if an analyst from the lead underwriting firm comes out and emails a select group of highly valued investors without emailing all of their retail investors, then not only does it demonstrate a lack of confidence in the company it has underwritten, it has also engaged in the manipulation of the market it was hired to establish in a fair and balanced manner.

Does Facebook have the potential to be a great long-term play? Sure it does. It made two very valuable acquisitions when it purchased Instagram for $1 billion dollars and Karma for an undisclosed amount. Facebook also engages in mobile media and has established a string presence across all operating systems, which leads to the potential of ad revenue being generated through those channels. That being said, I'd like to further examine the numbers, as should any potential investor before he or she chooses to establish a position in Facebook.

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