After more than a year of speculation on when and if it was going to happen, social media giant Facebook (Nasdaq:FB) issued shares to the public back in May. The initial public offering (IPO) price was $38 and raised an estimated $16 billion for company insiders and other earlier investors. The stock briefly traded above $40 per share, but has fallen steadily since. Warren Buffett advised against buying into the stock at its IPO price and appears to have been proven right so far. Below are three key reasons why he did not invest.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

Buffett Generally Avoids Technology
Buffett has a reputation for investing in companies with business models that will stand the test of time. Coca-Cola (NYSE:KO) is a great example. For the past century or so, it has sold its namesake soft drink throughout all parts of the globe. Regardless of what happens on the Internet or across world economies, people will continue to demand carbonated drinks mostly made of sugar.

Coke has been one of Buffett's most successful investments and is a position he has held for a number of decades now. In contrast, most businesses in the technology space move rapidly. As a result, their business models are extremely difficult to predict. Facebook may currently be growing rapidly, but a similar competitor named MySpace was also growing briskly several years ago. MySpace has nearly fallen off the earth in terms of popularity and the ability to attract advertising dollars. This could just as easily happen to Facebook within a few years.

He Also Tries to Avoid IPOs
In addition to generally avoiding investing in technology companies, Buffett is skeptical of companies that go public through an IPO. This is for a good reason, but company insiders and investment banks try to bring a company public at the highest price possible. They will look to do it when market sentiment is positive or when investors are overly positive on a particular industry or popular business model.

Facebook's timing wasn't perfect, but it was speculated that company insiders rushed to sell shares in the IPO. Sales of shares, when the company was public, kept ratcheting up the overall implied value of Facebook. It even reached around $100 billion at one point, even though it is projected to reach about $5 billion in sales for all of 2012. At this point, insiders that owned shares are still fantastically wealthy on paper. Investors that got in on the IPO price lost a huge portion of their initial investments.

Facebook Is too Difficult to Value
Buffett recommends that investors develop a circle of competence and only invest in what they know and understand. He suggests that investments not falling into this category be placed in the too-difficult-pile, or namely an investment candidate that is likely too hard to value with any level of accuracy.

Buffett has been quoted as not being interested in investing in Facebook. His reasoning follows the above. Its business moves too fast, there was too much hype during the IPO process and the company is simply too difficult to value. He did state Facebook has an extraordinary business, but these are famously difficult to come to an investment opinion on.

The Bottom Line
Investors that followed Buffett's advice to avoid Facebook from its IPO price are doing pretty well; the stock is down to $27 per share. The stock market capitalization is down to $58 billion, but still discounts many more years of rapid growth to get sales up to where sales multiples look anywhere near reasonable.

At the time of writing, Ryan C. Fuhrmann did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  2. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  3. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  4. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  7. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  8. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  9. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  10. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center