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With all the hoopla over Facebook, what do you recommend that individual investors do?

May 24, 2012

I normally don’t like to discuss particular stocks in the Ask George section, but I’m going to make an exception with Facebook because it is instructive on two fronts: 1) because of all the hype and 2) because it says something about IPO’s in general.

With all the hype about Facebook, I think there is a very good chance that the stock is significantly overvalued—even after falling about 20% from the IPO price. The stock currently trades at about 22 times revenues and 76 times trailing earnings. In other words, the company has to grow phenomenally to justify its current valuation. While it is possible for Facebook to achieve the necessary growth in revenues and profits, that seems unlikely to me. The company would have to do just about everything right for quite a long time.

This brings me to IPO’s in general. My personal view is that they are often a “rigged game” designed to benefit the investment banks and some of their institutional investor friends. There is substantial academic research showing that the majority of IPO’s do not perform well for several years after the initial price surge following the offering. (And Facebook didn’t even make it beyond the first day before fading.)

I much prefer to focus on seasoned companies with established track-records and cheap valuations.  In the upcoming (June 2012) issue, the Turnaround Letter will look at some interesting stocks trading well below their IPO price. Also, in contrast to Facebook, we will examine a household name technology company trading at a fraction of sales and a very low multiple of earnings.

(Question submitted by K. Moore)

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