Weighing in on the Facebook IPO

The ‘historic’ Facebook IPO has been all over the news.  Based on the hype, I expected the stock to jump from $38 and go into the $40s or $50s before crashing down to somewhere around $20, where I think it belongs and where I may actually be a buyer.

But I was actually surprised to see the stock drop so quickly.  On day 2 FB dropped below the IPO price of $38, meaning that all of those institutional investors who were priveledged with getting thousands of shares didn’t make anything on the IPO, not yet anyway.  Here’s my two cents on the whole thing:

I’m weary of investing in Facebook at any price because a) it’s trendy, b) most of its heavy users are young, c) a growing number of users access facebook on their smartphone, and d) the company solely relies on advertising revenues.

Trendy websites come and go …  One obvious example is My Space.  Also think about the giant web portal AOL and its instant messenger service that me and my friends were signed onto for about 10 years straight.  (I kind of miss it)  You never know, a few years from from now, we may be saying, “hey, remember when everyone went on facebook?  that was crazy!”.

As for my point about most of its users being young, this is undesirable to most Internet advertisers because they measure success by how many users clicked on their ads and actually purchased something on their website.  Well, the first problem is that the younger generation ignores advertisements and feels entitled to getting everything on the Internet for free. Secondly, even if users did click the ads, a lot of them are too young to have credit cards.

Then there’s the whole mobile problem that has been getting a lot of attention lately.  Facebook currently makes zero profit from users that access it on mobile phones.  I’m sure they’ll figure out how but I think its going to be hard for Facebook to convince companies of the value of putting their ad on someone’s phone while they’re playing ‘words with friends’.

Finally, there’s the important issue of valuation.  A company sets its IPO price in a way that it can make as much money as possible and I think Facebook did a great job in doing that.  For example, if the price was set much lower and the price then sky rocketed 30% like it does with many other IPOs, then that would be money left on the table because it’s the shareholders, not Facebook as a company, that make money off share gains after the initial public offering.

However, the downside now is that Facebook is probably too expensive for shareholders to realize any significant gains in the near future.  If you’re new to investing, you may be thinking, “Huh?  $38 isn’t expensive!  Google is $600.  That’s expensive”.  But actually, Google is much much CHEAPER than Facebook.  That’s because the price alone is meaningless.

It’s the price per earnings that actually matters and Facebook’s current P/E of $74 is ridiculous!  Why pay $74 for each dollar in Facebook earnings when you get more bang for your buck from similar companies like these:

Google       $18
Yahoo         $17
Microsoft    $11
Apple          $14

(If the whole price/earning thing sounds confusing, read my previous article on the basics of evaluating stocks for beginner investors.)

Don’t get me wrong, Facebook has a lot going for it and can offer companies a terrifying amount of information about its users that allows them to target their ads in a way that has never been possible.  (EX: Show my ad only to guys who are ages 18 to 24, single, college-educated, live in CT, have at least this many facebook friends, have been to any of these places recently and “like” this brand or this celebrity)  Crazy!  At the right valuation, I would be a buyer of FB, but let’s not get carried away.  This stock isn’t going to skyrocket any time soon and could definitely lose more ground over the next few months.  Intsead of buying FB, you’re better off with GOOG.  An $18 P/E is a steal for a growing technology company that is diviersified in everything from web search to android phones to driver-less cars, even if Google+ is a complete ghost town!

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