Lessons from the Social Network's IPO Fiasco
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Shares of Zynga (NASDAQ: ZNGA) are down by nearly 60% since their much hyped IPO seven months ago, and Facebook (NASDAQ: FB) is currently trading below $23 after reaching a high of $45 in their first day as a publicly traded company. There are some important lessons to be learned, and remembered, from these deplorable IPOs.
Newton had the great good luck to get into the South Sea Bubble early. He made a really decent investment and a very quick killing, which mattered to him. It was enough to count. He then got out, and suffered the most painful experience that can happen in investing: he watched all of his friends getting disgustingly rich. He lost his cool and got back in, but to make up for lost time, he got back in with a whole lot more (some of it borrowed), nicely caught the decline, and was totally wiped out. And he is reported to have said something like, "I can calculate the movement of heavenly bodies but not the madness of men." - Jeremy Grantham
It has happened forever; this was just a new episode showing how painful investment decisions can turn out to be when they are based on greed and lack of reasoning. Everybody was fantasizing about becoming a millionaire as an investor in Facebook or Zynga, and most of those anxious investors didn't even take the time to think about the rationale behind a purchase at those ridiculous prices.
Facebook came to the market at valuation ratios well above other innovative companies in the tech business, and without a proven buisness model. Why would someone pay more than $100 times for a dollar of earnings in Facebook when Google (NASDAQ: GOOG) is available at a P/E ratio around 18?
Google is not only much cheaper, it has the undisputed leadership position in online advertising, a successful business model producing tons of cash from search engine monetization and many innovative projects with disruptive potential. Some Investors probably thought that Facebook was the next big thing, only because they see the popularity of the platform, and did not make an effort to go through the pros and cons of investing in Facebook at those stratospheric valuations.
As for Zynga, the company is in the business of selling “virtual goods,” and it is deeply dependent on Facebook. You don't need a PHD to understand we are talking about a very risky investment here. Still, greed can be a powerful force driving some of the most stupid decisions, and the “social network boom” was used as an excuse to justify the unjustifiable.
I'm not saying these kinds of companies should not go public, but investors need to do their homework and understand the risks. Growing demand for a product or service doesn't necessarily mean a good investment idea, airlines have destroyed a lot of wealth from their investors while at the same time air traffic has been steadily growing over the last decades.
Investors need to think about the profitability picture for each company, their competitive advantages and valuation among other important aspects. Furthermore, when everyone is bullish about a sector or particularly hot IPO, chances are you are looking at a lousy investment proposition.
The fact that big banks like Goldman Sachs (NYSE: GS) or JPMorgan (NYSE: JPM) are bringing these IPOs to the market and recommending a purchase to their clients means absolutely nothing. Remember, these are the same companies which should have gone broke due to their spectacular failure to keep risk under control during the credit bubble. The same who call their clients “Muppets” or lost billions of dollars in a strategy which was: “flawed, complex, poorly reviewed, poorly executed and poorly monitored.”
There is just no substitute for independent thought, the anxiety of the masses and recommendations from the press, brokers or investment banks, can be very harmful to your wealth. Before making the next investment decision don't forget to do your homework, this will increase your chances of success, and if you fail, at least you can learn something from the experience.
acardenal owns shares of Google. The Motley Fool owns shares of Facebook, Google, and JPMorgan Chase & Co. Motley Fool newsletter services recommend Facebook, Goldman Sachs Group, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.