Article from NYTimes.
Facebook shares will be tempting to buy when they start trading on Friday. The company has hefty profit margins, a household name and a shot at becoming the primary gateway to the Internet for much of the planet.
But if history offers any lesson, average investors face steep odds if they hope to make big money in a much-hyped stock like Facebook.
Sure, Facebook could be the next Google, whose shares now trade at more than six times their offering price. But it could also suffer the fate of Zynga, Groupon, Pandora and a host of other start-ups that came out of the gate strong, then quickly fell back.
Even after Facebook supersized its offering with plans to dole out more shares to the public, most retail investors will have a hard time getting shares in the social networking company at a reasonable price in its first days of trading.
Facebook’s I.P.O. values the company at more than $104 billion. And the mania surrounding the offering means Facebook shares will almost certainly rise on the first day of trading on Friday, the so-called one-day pop that is common for Internet offerings. At either level, Facebook’s price is likely to assume a growth rate that few companies have managed to sustain.
New investors, in part, are buying their shares from current owners who are taking some of their money off the table, a sign that the easy profits may have been made. Goldman Sachs, the PayPal co-founder Peter Thiel, and the venture capital firms DST Global and Accel Partners are all selling shares in the offering.
“It is a popular company, but it is still a highly speculative stock,” said Paul Brigandi, a senior vice president with the fund manager Direxion. “Outside investors should be cautious. It doesn’t fit into everyone’s risk profile.”
For the farsighted and deep-pocketed investors who got in early, Facebook is turning out to be a blockbuster. But by the time the first shares are publicly traded, new investors will be starting at a significant disadvantage.
Following the traditional Wall Street model, Facebook shares were parceled out to a select group of investors at an offering run by the company’s bankers on Thursday evening, priced at $38 a share. But public trading will begin with an auction on the Nasdaq exchange on Friday morning that is likely to push the stock far above beyond the initial offering price.
That is what happened to Groupon last fall. Shares of the daily deals site started trading at $28, above its offering price of $20. It eventually closed the day at $26.11.
The one-day pop is common phenomenon. Over the last year, newly public technology stocks, on average, have jumped 26 percent in their first day of trading, according to data collected by Jay R. Ritter, a professor of finance and an I.P.O. expert at the University of Florida.
In many of the hottest technology stocks, the rise has been more dramatic. LinkedIn, another social networking site, surged 109 percent on its first day in May 2011, and analysts say it is not hard to imagine a similar outcome with Facebook, given the enormous interest.
Unfortunately for investors, the first-day frenzy is not often sustained. In the technology bubble of the late 1990s, dozens of companies, Pets.com and Webvan among them, soared before crashing down.
At the height of the bubble in 2000, the average technology stock rose 87 percent on its first day. Three years later, those stocks were down 59 percent from their first-day closing prices and 38 percent from their offering prices, according to Professor Ritter’s data.
The more recent crop of technology start-ups has not been much more successful in maintaining the early excitement. A Morningstar analysis of the seven most prominent technology I.P.O.’s of the last year showed that after their stock prices jumped an average of 47 percent on the first day of trading, they were down 11 percent from their offering prices a month later. Groupon is now down about 40 percent from its I.P.O. price.
“It’s usually best to wait a few weeks to let the excitement wear off,” said James Krapfel, an I.P.O. analyst at Morningstar who conducted the analysis. “Buying in the first day is not generally a good strategy for making money.”
There are, of course, a number of major exceptions to this larger trend that would seem to provide hope for Facebook. Google, for instance, started rising on its first day and almost never looked back.
Even among the success stories, though, investors often have had to go through roller coaster rides on their way up. Amazon, for instance, surged when it went public in 1997 at $18 a share. But the stock soon sputtered, and it did not reach its early highs again until over a decade later. The shares now trade near $225.
More recently, LinkedIn has been trading about 140 percent above its offering price of $45, enough to provide positive returns even for investors who bought in the initial euphoria. But those investors had to sweat out months when LinkedIn stock was significantly down.
Apple is perhaps the clearest example of the patience that can be required to cash in on technology stocks. Nearly two decades after its I.P.O. in 1980, it was still occasionally trading below its first-day closing price, and it was only in the middle of the last decade — when the company began revolutionizing the music business — that it began its swift climb toward $600.
Facebook’s prospects will ultimately depend on the company’s ability to fulfill its early promise. It has a leg up on the start-ups of the late 1990s, which had no profits and dubious business models. Last year, in the seventh year since its founding, Facebook posted $3.7 billion in revenue and $1 billion in profit.
But investors buying the stock even at the offering price are assuming enormous future growth. While stock investors are generally willing to pay about $14 for every dollar of profit from the average company in the Standard & Poor’s 500 index, people buying Facebook at the estimate I.P.O. price are paying about $100 for each dollar of profit it made in the past year.
When Google went public in 2004, investors paid a bigger premium, about $120 for each dollar of earnings. But the search company at the time was growing both its sales and profits at a faster pace than Facebook is currently.
Facebook may be able to justify those valuations if it can keep expanding its profit at the pace it did last year, a feat some analysts have said is possible. But especially after the company recently revealed that its growth rate had slowed significantly in the first quarter, the number of doubters is growing.
“Facebook, by just about any measure, is a great company,” Professor Ritter said. “That doesn’t mean that Facebook will be a great investment.”
Read more here.
Read Full Post »
Blog of Intellectual Capital 