Facebook IPO Makes Few Friends

By Sham Gad | May 22, 2012 AAA

The most widely anticipated tech IPO since Google (Nasdaq:GOOG) is finally here. Facebook (Nasdaq:FB) managed to pull off the one of the biggest IPOs of all time at $38 a share, valuing the company at over $100 billion. Demand for shares was intense as investors clamored to own part of what was supposed to be a wildly successful IPO.

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Wishful Thinking
The hype is over. At the peak, FB shares popped to $45, up about 15% from the IPO price of $38; but the shares quickly began heading lower from there and were up about 0.5% on the first day of trading. Now that the hotly anticipated IPO is over, it appears that it was wishful thinking to think shares would have the one day share price pop that was reminiscent of the late 1990s. Now its time for reality and the picture is not so friendly. Facebook may be a great company, but as an investment it's a foolish bet today.

The company is now valued at 88 times earnings. On a price to cash flow basis, the multiple is even higher; and while Facebook certainly has the potential to grow its earnings rapidly, the current valuation implies a significant amount of growth, even by tech standards. Similar to investing in gold, an investment in Facebook today is a bet that hopefully one day, someone will be around to buy it from you at a higher price. The company's $105 billion valuation is for a company that is now generating less than $1 billion in free cash flow per year. As the newness of the IPO wears off, reality will kick in.

SEE: Evaluating The Facebook IPO

Opportunity Cost
As one of the most successful and widely held stocks today, many investors in Apple (Nasdaq:AAPL) likely sold some Apple shares above $500 in order to participate in the Facebook craze. The assumption is the success achieved at Apple could happen at Facebook. Expect to wait a long-time for that to happen. Apple sells incredibly useful products, while Facebook offers services that may turn out to be more social, versus useful. Remember Groupon (Nasdaq:GRPN), the online group buying site that was going to change the way people made purchases? Shares trade for less than $12, well below the IPO price.

SEE: IPO Basics: What Is An IPO

The Bottom Line
When it comes to popularity, very few companies are as popular as Facebook. No company has reached an audience of 800 million plus people as quickly, but popularity will only take an investment so far. Sooner or later, the metric that matters most, cash flow generation, takes over, often leaving many investors holding the bag.

SEE: How Facebook's IPO Will Make People Rich

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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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