Facebook Stock: Financial Ouch

facebook wonka Facebook Stock: Financial Ouch

A few months ago I wrote an article providing 5 reasons not to buy Facebook stock. As of now, I’m quite happy that I didn’t. For those that aren’t aware, Facebook (FB) fell nearly 9% on Tuesday alone, and is down about 26% from its high. In short, anyone who tried to buy into this IPO got their haircut. Was this by accident? Absolutely not!

Why Facebook Is Down

There is a very simple reason Facebook stock is in the pits now: it was over-valued by Morgan Stanley. That’s it plain and simple. Morgan Stanley made Mark Zuckerberg & Co. very wealthy, and in return gave a haircut to anyone who was willing to buy.

To make things worse, let’s dig in a bit into how IPOs work. Morgan Stanley was the primary underwriter, meaning they helped value the company and usher them through the process of an IPO. Now, to show support for the company they are helping out, underwriters will often allocate a certain amount of money to help “support” the stock price during the first day or so of trading.

What does this mean to you? In short: they artificially supported the stock price at their valuation ($38.00/share) which means anyone buying during the first day got shilled. Notice that the first day of trading, the price didn’t dip below $38.00? That was Morgan Stanley magic at work there.

People are trying to blame a bunch of things like NASDAQ having problems: yawn. The stock was valued too high, and anyone saying otherwise is just trying to comfort themselves.

Facebook Stock Over Priced?

How dare I make such a claim about the price of Facebook stock. After all, Joe Schmoe investor can easily afford $38.00 to purchase a share of trendy stock for a company they use everyday, right? Unfortunately, stock price is meaningless. Facebook could make their stock price $19.00 a share simply by splitting the stock, or $76.00 by doing a 2:1 reverse split.

What you really need to look at are ratios and market capitalization. The P/E ratio of Facebook stock is about 100 right now! Typically, I won’t look at a stock over 25! Of course, that isn’t the only metric one should look at, but bells and whistles should be ringing. Morgan Stanley valued Facebook at a P/E of 122!

Now, looking at market capitalization, Facebook is currently at 66.28 Billion. That’s relatively meaningless to most people until you consider this:

 

 
If the problem doesn’t jump out right away, allow me to clarify: each of those companies provides physical products, and have huge capital tied up in physical assets. Some might try to make the Google argument, but the problem being that Google as a P/E ratio of 18.

If you want to make the Google argument, then my argument back is: why not buy Google? They have similar business models & Google is more dominant in that they also have 61% of the mobile OS (Android) marketshare (which ironically enough, Facebook noted they will have trouble in the mobile market).

Is Facebook A Complete Bust?

I don’t believe Facebook stock is a complete bust, but the price needs to come out of the stratosphere, or they need to beef up their earnings because what I see is not impressive whatsoever. We also have to consider that Facebook will need to get much more creative when it comes to generating revenue as they probably are going to plateau with new users, and their ad space is basically saturated (at least online). Revenue growth is going to be an uphill battle without clever thinking.

Moral of the Story

Just because a big company is going public, it doesn’t mean profits are guaranteed. Anyone who purchased this stock without knowing how to value it got destroyed, and chances are, they’ll need to wait quite some time before they even recover, let alone profit. Look before you buy!

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Comments

    • says

      Hey SB!

      I don’t write it off completely, as mentioned in the “Is Facebook a Complete Bust?” section, I do mention that the stock price needs to come down (which the market is trying to do) or earnings need to rise greatly. But for the P/E to even be brought 25, Facebook would need to increase earnings 400% to $1.24 to justify a $31.00 share price.

      I would stay on the sidelines until one of those two things happens. There is absolutely a bright future for Facebook if they make the right decisions and position themselves properly, I just can’t buy at this price.

      Thanks,
      Timothy

  1. says

    I have not seen the numbers from the first few days of trading to see how many shares wre purchased at the ipo price, but I am sure it was ridiculous. This is exactly why so many people are lousy at investing-they get involved in the “hype” instead of analyzing the numbers logically, as you have.

    All the research in the world on a single stock guarantees nothing, as one wrong decision by the leadership team can send the stock into a tailspin within hours. Personally, I have only invested in a single stock once-got lucky and made a little-but I am a firm believer in “spreading risk” in a variety of stocks that are well managed by someone else-I think they call that mutual funds.

    A a sidenote, what about Zuckerberg denouncing his U.S. citizenship to avoid a tax bill when he sells his stock? Is kind of interesting that this self-proclaimed atheist does little in the way of philanthropy, but also does not want his money to go to the Government to disperse to those less fortunate than he. (Wouldn’t that be about 100% of Americans?) His $100M donation to Newark NJ school system is debatable as to intent, both because of the timing and his philanthropic track record before and after. He will “give” money to startup software companies, but is this philanthropy or investing?

    You were right on track in your “5 points” post, hopefully your followers were wise enough to listen.
    Great Job, Timothy.

    Steve

    • says

      Hey Steve,

      Thanks for chiming in! Few companies have power as centralized as Facebook and Mark Zuckerberg. The only other companies that I can think of are Ford, and Apple up until the loss of Steve Jobs.

      One should be quite wary of a company with such a young leader and such power. I don’t know enough about Zuckerberg to comment on his capabilities. To be fair to him, he did grow it to where he has.

      The character of a leader is a whole other aspect. I’ve not looked much into Zuckerberg’s personal life, but you certainly raise important questions.

      Some might dismiss those qualities as superfluous, but the character of your leader can determine the company’s future path.

      Great hearing from you Steve, and thank you for stopping by to share your wisdom.

      Thanks,
      Timothy

  2. says

    I wish I read this before I bought some FB. Ouch! Great breakdown. This post is how you are supposed to do it. Come by and check out Facebook Fakeout, Failure, Fiasco to see how you’re NOT supposed to do it!

    • says

      Hey Buck!

      I’m sorry to hear. I can’t really blame anyone for wanting to buy in. Facebook can be an excellent investment if they position themselves properly and execute well, but I need to see more from them before I buy in. Thanks for stopping by!

      Thanks,
      Timothy