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!
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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:
|Kraft Foods – KFT||68.24 B|
|Home Depot – HD||72.60 B|
|Honda – HMC||58.79 B|
|3M – MMM||58.68 B|
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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