Facebook (FB) has already earned the title of being among the most disappointing IPOs of all time, if not the most disappointing. First, the stock did not begin trading on time, then there were issues with investors trying to cancel trades. The stock opened higher, but has since fallen off a cliff, and the company's hoodie-wearing-CEO is nowhere to be found.
The situation is a perfect example of underwriter Morgan Stanley (MS), a company that has been a part of several disastrously overvalued IPOs in the last year, pricing the IPO considerably too high. It went from earning $10 billion to $16 billion in a matter of days, making it the second largest IPO of all time. These facts are all well-known, but what's unknown is if investors should now buy FB under $31.50. I say no. In fact, I have a limit order and I am waiting to buy FB at $22.50, allow me to explain.
My reason for initiating a buy if the stock falls to $22.50 has nothing to do with its already ridiculous valuation or its fundamentals. The stock is expensive, but so are most in the social media space, and although Facebook's valuation may be more expensive than others, it's still not unheard of considering the hype that surrounded this company. Yet my position on the stock is purely technical, actually psychological. Because social media, and high profile stocks have a long history of falling by 50% from their high and then returning gains of at least 50%, all in a couple months time.
I first explained this trend back on November 29, 2011, right before I bought Groupon (GRPN) and rode it higher for a 40% gain. This article breaks the trend down according to individual charts and even provides for my reasons of why I think it occurs. My theory on this trend has since evolved.
At the time I wrote the article for Groupon, the trend had been in place for every single social media stock before it, during the previous year. It had repeated itself for Renren (RENN), LinkedIn (LNKD), Pandora (P), Zillow (Z), and then went on to take place in the shares of GRPN. It also occurred in the shares of Angie's List (ANGI) and Home Away (AWAY), but I never had the opportunity to take part in AWAY, and only partially in ANGI, nor did I identify the trend in either stock. So let's take a look at this trend by looking at the companies I just mentioned, and then you can decide for yourself whether or not FB may fit the bill.
- Renren reached a high of $24 the day of its IPO. Between May 5 and June 24, the stock fell 70%, but then rebounded by July 7 to post gains of 70% from its June 24 low.
- Linkedin reached a high price of $122.70 and then fell 50% in the following month. It then increased 75% in the following three weeks.
- Pandora reached $24 on its IPO, and then fell 50% in the following five trading days. It recovered very quickly to post gains of 50% in the five days that followed the loss. This was one of the most volatile two weeks of any IPO that I had ever witnessed.
- Zillow hit $60 on its IPO, and then lost 60% in the following month. It then recovered to post gains of 55% in the eight days that followed.
- Groupon hit a high of $31.14, the day of its IPO. On the day I wrote my article, the stock was priced at $15.24 which was November 29. By December 9, the stock had recovered to post gains of more than 50%.
To see these trends by chart and in more detail click here.
The trick with this trend is that there is no standard period where it will takes place. The stock may fall one week or one month following its IPO. The important factor is to watch for it to fall by more than 50% from its high, and if so, watch for it to rise.
There is one more factor that must be considered: I called this trend in both Zynga (ZNGA) and Yelp (YELP) and neither completed the trend. YELP fell from $31 to $20 in the five days that followed its IPO, then rose 50% in the following three weeks. However, I don't consider this to be a completed trend because the stock never fell a full 50%, therefore I missed it. Zynga actually fell following its IPO, therefore it never had the opportunity to complete the trend. However, it did almost double after falling further in 2012.
The fact of the matter is that FB is ridiculously overvalued, as were all of these stocks, following each company's IPO. I think the reason this trend occurs is because investors want to be a part of IPOs because of a belief that it is quick money. Yet only few plan to actually hold the stock as a long-term investment.
Following the IPO I think it causes a domino effect of investors selling shares until the stock reaches a price that the market believes it is worth, or is undervalued, which happens to be around a 50% loss. Once the stock falls with this level of loss, I think investors begin to buy back and it then causes another domino effect as investors believe it has bottomed, which causes it to rise as quickly as it fell.
Of course this is just my theory and there is no evidence to suggest it as the truth, but it does make sense. I think it only occurs in stocks that are extremely overvalued with large market capitalizations that are considered somewhat speculative, which almost describes Facebook with perfection. Whether you see the trend or believe that it is nothing more than coincidence is for you to decide.
There is a good chance that this trend will no longer occur, and if so, then it was fun while it lasted. I personally wouldn't touch FB at this time, but I do have a limit order waiting if the stock hits $22.50.
Additional disclosure: The information in this article is for educational purposes only and is not to be used to make any particular investment choices. Please consult your financial advisor before making any investment decisions.