2/2/2012 9:30 PM ET|
How to buy Facebook -- if you must
Despite the risks, a lot of investors will want to buy in. Consider this guidance on finding the right time to purchase shares.
I can think of several good reasons not to buy scratch-off lottery tickets, but states will nonetheless sell more than $30 billion worth of them this year. So it is with Facebook's hotly anticipated initial public offering. The company filed papers with regulators on Wednesday and is expected to start selling shares in the spring.
History says don't buy in. Most IPOs lose money, studies show, which makes sense, because they represent a highly informed class of investors deciding to sell. And most of last year's dot-com IPOs -- including LinkedIn (LNKD), Groupon (GRPN) and Zynga (ZNGA) -- sit solidly below their first-day opening prices.
Valuation says stay away, too. Facebook brought in $3.7 billion in revenue last year, and its post-IPO stock market value is estimated at $75 billion to $100 billion. That suggests it could trade at 20 to 27 times revenues, making it perhaps the most expensive stock in America. The median price-to-revenue ratio for U.S. companies is about 1.4. Wildly popular growth stocks like Red Hat (RHT) and Intuitive Surgical (ISRG) trade with ratios of 8 to 10.
But again, none of this matters to the many investors who are determined to buy in. And who knows? They might make good money. Google (GOOG), after all, defied the odds. Its shares began climbing immediately after its 2004 IPO. They've now multiplied five times in value. And besides, Facebook itself has an interest in seeing its stock price rise after the offering, assuming it will want to conduct a follow-on offering later.
So forget about the "why" or "why not" of Facebook's IPO. Here's the "how" for investors who won't get in on shares at the subscription price and will have to buy in regular trading -- that is, most of them.
Don't buy at the open. The aforementioned IPOs closed lower than they opened on their first day, with the exception of Google, which closed only fractionally higher and which at one point during its first day traded 4% below its opening price. So wait for the open and put in a limit order that specifies a maximum price of 5% or so below the open. If it doesn't get executed, you can always change it to a market order (for immediate execution) shortly before the close.
Don't pay attention to elaborate Wall Street valuation analysis, especially if it involves the term "network effect." Valuation is deeply important for long-term stock performance, but the way to tell which stocks are cheap is to compare factors that are mostly known today. Apple (AAPL), Google, Intel (INTC), Microsoft (MSFT) and Cisco Systems (CSCO) are attractively priced, based on their current stock market values, earnings, cash flow and cash on hand, and perhaps this year's growth projections. Projections for their income in 2018 don't matter, because those amount to guessing. Same goes for Facebook.
The "network effect" refers to goods and services that become more valuable as more people use them. The key here is that they become more valuable to their users, but not necessarily to their investors. Whether investors make money depends on how much they paid to begin with. The Buffett effect, in other words, trumps the network effect.
Do bet small, and take profits sooner rather than later. At Facebook's price, investors probably shouldn't fall in love with their shares. Consider that Google's post-IPO rise started from a base value of less than $25 billion in 2004. Facebook, again, will start from a value of $75 billion to $100 billion. That means that for investors to double their money in five years, Facebook would have to become about as valuable as Google is today. It could happen, but for now, Facebook brings in about one-tenth the profits of Google.
And there's a big difference between having Google-like potential and becoming Google.
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