It’s been a week since FaceBook’s eponymous IPO, and as an innocent bystander*, all I can say is, “Wow!”
*At this time, it’s tough to determine who is and isn’t an innocent bystander with the FaceBook IPO. I didn’t buy any individual shares of FaceBook, but it’s possible I have some exposure via some mutual funds I own, because many shares were purchased by funds and other institutional level buyers.
OK, that out of the way, I think there are some important takeaways the common investor can learn from FaceBook. Here are a few of my observations about the FaceBook IPO.
1. The little investor is always last in line for IPOs. IPOs are interesting events and a lot of wealth is created and lost during these initial stock offerings, but let’s get one thing clear – they never favor individual investors. They favor the company going public and the underwriters who help them take their stock into the market. I think Warren Buffet said it best when he was asked about investing in FaceBooks’s IPO:
“The idea that something coming out…that’s being offered with significant commissions, all kinds of publicity, the seller electing the time to sell, is going to be the best single investment that I can make in the world among thousands of choices is mathematically impossible,” said Buffett.
The big institutions and underwriters will always have the first dibs on buying and selling shares of stocks, which means even if you get it right after the stock goes public, you are making your trade based on what someone else is willing to sell for – so they are either taking money off the table, or you are making them an offer they can’t refuse. In either case, you aren’t getting value, you’re paying a premium. In the case of FaceBook, shares immediately jumped 10% at the open, which means many of the initial sellers made an immediate 10% gain on their investment, while those buying into the IPO were buying in at an already inflated price compared to the announced offering price.
2. Individual investors don’t have access to the same information available to the big investors. FaceBook’s IPO is already under investigation regarding whether or not they broke securities laws by giving larger clients access to information they didn’t make public to all investors. The claim is that in the week leading up to the IPO, a FaceBook executive told the underwriters to cut Q2 earnings forecasts based on weaker than expected data. There is no problem with sharing data, as long as it is made available to everyone at the same time. But if they only gave the information to the big investors, then individual traders are left holding the bag. More on this topic.
3. Beware of the hype. The initial price estimates for FaceBook stock were in the $28-$35 range. In the week leading up to the IPO, the price estimate was adjusted to $34-$38 per share, finally settling in at the top end of the range. In addition, FaceBook increased the number of shares they were offering by 25%. They were able to both raise the IPO price and the number of available shares due to the strong demand for FaceBook stock. This came about due in part to the press hyping the IPO, and because many investors were looking to hit a home run. The price increase and larger number of outstanding shares dramatically changed the landscape for the value of each outstanding share and the last minute changes played a large role in the quick rise and subsequent fall of the stock price directly after the IPO.
4. Buy for the long term – not the IPO jump. A lot of people who bought FaceBook hoping for an initial jump in the offering price were likely very pleased – as FaceBook jumped 10% almost immediately after it began trading. But they were probably only happy for about five hours, because share prices dropped right afterward, finally closing the first day of trading slightly above the offering price. FaceBook shares quickly dropped under the initial offering price on the second day of trading, and continue to trade lower than the IPO price. Those who bought for the flip are happy if they got out of the trade in the first few hours, but those who gambled on a larger rise or who got greedy, got burned. The lesson learned here is that you don’t buy into an IPO hoping to flip it in hours or days. Take some time to review past IPOs in various industries to see how volatile they were within the first few hours, days, and weeks of trading (bonus points for researching the performance of recent tech IPOs). Unless you have some inside information (which is illegal), then you are almost always better off buying for the long haul, or waiting on the sideline for things to stabilize. And if you are buying for the long haul, buying slightly above or below the offering price won’t matter that much in the end.
5. Greed can burn you. There is nothing wrong with wanting to make money – that is the point of investing. The problem comes when greed causes poor judgment – like someone trying to hit a home run, and gambling their child’s college fund on FaceBook stock, even though they said they weren’t sure it was a good bet. I hope they weren’t able to place the trade, or if they did, that they were able to get out without much of a loss. Investing in IPOs can often be a gamble, so if you do it, invest with your mad money – not money you need for your retirement or college fund.
There is Much More to Come
This isn’t an indictment of FaceBook or their stock. FaceBook is going to be around for a long time, and this is just the beginning of what should be one of the hottest and most talked about stocks for the next few years. I’m sure we will see a lot of volatility, some ups and downs, and plenty of opportunities for people to make and lose a lot of money. And that’s great – that is what capitalism and the stock markets are all about. But right now, FaceBook stock probably isn’t for the average investor, who is usually better off sticking with index funds and mutual funds for the majority of his or her investments. I’m going to keep watching FaceBook stock, but only from the sidelines.
This article originally published May 25, 2012.