The Facebook IPO has now been and gone and Facebook shares are being traded on the NASDAQ exchange, so what lessons can you learn from this?

Whether you bought some Facebook shares in the IPO or not, if you are an investor in stocks and shares then it is likely that you will be tempted to buy shares in an Initial Public Offering like this at some point or other.

Looking back at recent IPO events can therefore give you an idea of what to expect, bearing in mind that not all IPOs are the same.

The Facebook IPO

Before we talk about the lessons learned, let’s first have a re-cap of the Facebook IPO itself to remind us.

The flotation of Facebook shares on the stock market had been anticipated for a long time and was hyped up to the point of fever pitch.

According to Facebook Inc.’s Registration Document published by the company with the Securities Exchange Commission (SEC) the company had:

  • $1 billion net income (earnings or profits) in 2011
  • Net assets of $4.9 billion at the end of 2011

Facebook’s shares were floated on the NASDAQ stock exchange at an initial share price of $38 valuing the total business at $104 billion.

This is a valuation of 104 times earnings and 21.2 times net assets.

Viewed alongside its peers, this valuation is very racy indeed and I remarked as much before the IPO, in my article titled “Facebook IPO.”

For example, Google traded on 20.4 times earnings and I asked the question, “is Facebook really worth 5 times the price of Google?”

Yes, I agree that Facebook looks like a well-run company with plenty of growth opportunities, but so does Google and I don’t agree that Facebook has 5 times the growth opportunities of Google.

Many stock market commentators remarked on this over-valuation before the float but there were still lots of investors wearing their rose-tinted goggles espousing the virtues of Facebook and how this time it is different.

As I write this, the Facebook IPO was 6 weeks ago, so let’s now take a look at what actually happened…

What Happened After The Facebook IPO?

Facebook’s shares were floated at a share price of $38 on the NASDAQ stock exchange on May 18th, 2012.

In early trading, the share price increased and peaked at $43.02 – a gain of about 13%.

However, by the end of the first day’s trading, the share price had fallen back to $38.23, a modest increase above the initial $38 share price.

Despite underwriters (I’ll explain these part 2) buying Facebook shares for the first few days of trading, the share price continued to fall, almost day by day, to a low of $25.87 on June 5th, 2012.

This price is 32% below the initial $38 price.

Since then, the Facebook share price has increased to $33.10 on June 26th, which is still 13% down on the initial $38 IPO price.

So what can you learn from all this?

Lessons Learned

1. IPO’s are not a one-way bet

If you wanted to make a quick profit on your Facebook shares, you have had to sell them on day 1.

Had you sold them on any day since then, you will have made a loss and you will continue to make a loss until Facebook’s shares rise above the price of $38 that you paid (which may never happen).

According to Privco, a US research firm, “historic evidence of IPOs that trade down in price as quickly as Facebook don’t ever recover.”

Note the use of the word “ever” as opposed to”usually” or “normally”.

The omens are not good for Facebook, but they could always be the first?

2. Even if growth prospects look good, the initial price can be wrong

After writing my article and tweeting about my analysis and opinions on Twitter, there was no shortage of people replying passionately about how Facebook is unique, etc.

Not one of those replies tried to justify the initial price and valuation.

They were all focused on Facebook being a good company with strong growth prospects.

We can debate the growth prospects but those prospects have to be related to the valuation/price in some way and the Facebook devotees seemed to be missing this relationship aspect.

Don’t make the same mistake yourself.

3. To make money with an IPO, the initial price needs to be below fair value, not above it

I’ve already compared Facebook to Google above and remarked that I don’t believe that Facebook is worth 5 times that of Google.

Even at today’s price, I don’t believe that Facebook is worth 3.4 times Google.

To put it another way, do you believe that Facebook with it’s quirky, fickle customer base is worth more than Amazon, Disney, McDonalds or Ford Motor Company, for example?

If you think it is, how confident are you?  What gives you that confidence?

4. Make sure the company has explained their rationale for their valuation

In the case of Facebook, this was absent from the documents lodged with the SEC prior to the float, but this is not always the case.

When a company publishes their valuation rationale, it makes it much easier for potential investors to critique and challenge that rationale.

If and when it stacks up and makes sense, it then provides you with a feeling of comfort that management is being realistic and not ripping you off.

It would have been nice to know Facebook management’s rationale for their sky high valuation, wouldn’t it?

We still don’t know that now, several weeks later, so I guess we never will or we may have to wait for Zuckerberg’s memoirs (which he will expect to sell to us again, no doubt.)

This post is getting on for 1,000 words already so I’m going to leave the last 5 lessons for part 2.

In the meantime, I’d be very interested in your views on the lessons listed above, so please leave me a comment below and tell me what you’ve learned from all this.

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