Should Contrarians Buy Facebook? Heck No!
Paula is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I’m a contrarian investor. If a stock plummets, my knee-jerk response is: “Should I buy it?”
When Facebook (NASDAQ: FB) IPO’ed, my level of interest in the stock was zero. As a general rule, I’m suspicious of IPOs, which represent a stock price that hasn’t been tested on the open market. I’m wary when a large group of company insiders decide they want to unload the stock.
Facebook’s May 18 IPO caused particular concern, as it valued the company at roughly $100 billion and offered an opening price at roughly 60 times EPS.
You don’t need to be a finance expert to immediately recognize how expensive that stock was. Google (NASDAQ: GOOG), the last mega-tech company to IPO (and a company with an arguably stronger moat), opened at “only” 40 times EPS. And that was during the glory-days bull economy.
I wasn’t surprised when Facebook stock plummeted immediately after its IPO, and we’ve all continued to watch it tumble for the past several months. By now, the stock has chopped itself nearly in half, down 44 percent from its initial opening at $38 to today’s trading price of $21. That’s enough of a drop that my fellow contrarians are asking: “Has it reached a reasonable price? Should I buy it?”
My response? An unequivocal no. Avoid Facebook stock. Here’s why:
#1: Still Expensive
Are you familiar with “anchoring”? Anchoring is a technique by which a seller sets a particular price in your mind -- “This sofa costs $2,999!” – so that when the item price drops to “only” $1,799, you’ll perceive the sale price to be a good deal.
In other words, anchoring is a psychological technique by which people evaluate prices relative to other prices, rather than evaluating the price in absolute terms, based on the underlying item’s intrinsic worth.
Many investors are looking at Facebook’s current stock price relative to its IPO price – “it used to cost $38 and now it’s only $21” – rather than looking at its price in absolute terms.
It’s absolutely still expensive, trading at a P/E of 82.2, according to S&P Capital IQ. That's jaw-dropping, even in the notoriously pricey tech world. In contrast, you can scoop up Google, now trading at a 3-month high, for a P/E of only 18.
#2: Big Sell-Off Coming Soon
Econ 101 teaches us that when supply rises and demand stays the same, prices drop.
Well, guess what? Facebook hits the 90-day “anniversary” of its IPO on Aug. 15, which means that company insiders will be permitted (under federal regulations) to sell an additional 268 million shares of company stock, according to USA Today. And given Facebook’s plummet, I have a gut feeling that many of those insiders will rush to flood the market with shares.
What next? Between Day 91 and Day 181, insiders will be allowed to sell an additional 137 million shares. In other words, more than 400 million shares will come on the market within the next six months.
That’s a scary proposition even for a company that’s fairly valued. For a company that’s already overvalued, though, all signs point to a further drop.
#3: Slower Growth
When growth accelerates, stock prices rise. But Facebook’s growth has been on a steady decline – from 55 percent to 45 percent to 32 percent over the last three consecutive quarters. That’s an argument to sell, not buy.
The Bottom Line:
Focus on Facebook’s absolute value, not its discount relative to its IPO price. As Fool analyst Alex Dumortier said, “Facebook shareholders should consider that horrific past performance does not mean their downside is now capped.”
PaulaPant owns shares of Google. The Motley Fool has no positions in the stocks mentioned above. 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.