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3 Investing Lessons from Facebook IPO No One is Talking About

Let me start by repeating what has already been repeated somewhere else. Facebook just raised US$ 16 billion in its historic IPO.

It sold 421 million shares for US$ 38 each, a price that valued the company at a mammoth US$ 104 billion, or 107 times its profits in the last year (P/E of 107 times!).

Now how much is US$ 104 billion in market cap? Well that’s 25% more than the combined market cap of India two biggest companies (by market cap) – TCS and Reliance Industries.

I’m a Facebook fan, only and only because of the connections it has helped me create with my friends and readers (that it can become a pastime or is dangerous for kids is another point of discussion). I’m on it for business reasons mostly, but I’m on it.

Like just last Friday, I conducted the first session of Safal Niveshak’s Friday Night Facebook Jam…where we had some great discussion around investing (Check out a part of the discussion here).

You can join the jam this coming Friday evening (25th May), between 7 PM to 9 PM.

Anyways, no matter what everyone is saying about Facebook and its IPO, I don’t believe the company is a fad, at least not technically — it’s been around too long.

I also don’t think its stock price is going to soar, then crash like is being predicted. As much as the social network can sometimes drive me crazy with its privacy changes and apparent arrogance, I don’t believe they are going to fail. Not in the short term or medium term, anyway.

In fact, I believe there are some serious (and surprising) lessons investors can learn from the Facebook IPO…lessons that must last a lifetime.

Let me start right here…

Lesson #1: How to value a company you love?
I’ve always suggested people to buy businesses that are simple to understand. And what could be simpler than a business whose products or services you own and love (like Facebook!).

Take the examples of some Indian businesses that fall in this category (of a large number of people loving their products/services) – Titan (watches and jewellery), HDFC (home loans), Hero Motocorp (bikes), ITC (cigarettes), Colgate (toothpaste), Nestle (Maggi!), Dabur (honey), Pidilite (Fevicol), Marico (hair oil), Asian Paints (paints), and Hindustan Unilever (so many products).

If you look at the last 10 year stock prices and valuations (P/E) of these companies, a majority of them have been great wealth creators and among the most expensive stocks listed in India.


Data Source: Ace Equity

One reason these stocks have performed well (except Hindustan Unilever over a 10-year period) – haven’t crashed much during bad phases – and have remained expensive throughout is that people love their products/services so much that, as investors, they are blindfolded to price their stocks at any levels (of course, these companies have been great performers all these years).

So I’ve had some of these like Titan and Asian Paints perpetually on my watch list – stocks I understand and would love to buy but can’t buy because I believe they are expensive.

And these stocks have disappointed me over the years, by continuing to rise (and rise) and always remaining ‘expensive’!

This, I believe, is also going to be the case with Facebook. If not at 107 times P/E, it will still remain expensive.

As the noted Yale University economist Robert Shiller has said, “Facebook is your ally in your quest to project [yourself] onto the wider world. That strong bond isn’t likely to fade anytime soon – although it could ultimately set up the stock for a steeper fall.”

“It sounds like the setup for a colossal bubble,” Shiller adds. “Price increases generate talk, and when people talk about it, the stories get amplified and that feedback leads to more of a price increase. Bubbles come to an end because they can’t be sustained unless the price keeps growing. As the price falters, the talk turns negative and then the price goes down further.”

So do I expect the prices of such Facebook-like stories in India (the ones mentioned above) to crash ‘sometime’ in the future?

I don’t know, but I would definitely love them to fall to my comfort levels before I buy them (though I already own Hindustan Unilever in my stock portfolio, which I believe I bought at a decent price).

So the lesson here is that while it’s always good to buy a stock whose business you understand and whose products you love or associate yourself with, you must not value the stock while being blinded by this love.

The sensible thing would be to understand the underlying business deeply and whether the stock price is justified in relation to the intrinsic value of the stock.

Keep your love for the company aside, and do a rational analysis.

Of course, the stock price might remain high in relation to the intrinsic value for ever, but then you can know this only in hindsight (like I’ve known for Titan and Asian Paints).

Warren Buffett has loved Coca Cola for long, and he bought a large chunk of its shares in 1988. But then, Buffett hasn’t kept on buying that stock just because he has kept on loving the product.

So, once again, the lesson is to never mix your love for a company with your rational analysis of that company.

By the way, can love and rationality co-exist? 🙂

Lesson #2: Never chase an IPO before or during the IPO
Now this is interesting! When Facebook first made noises about its IPO, a fund in the US bought loads of Facebook shares at an average price of US$ 200 in a private deal – or 5 times Facebook’s current price after getting listed!

Imagine what would’ve happened to the investors in the fund.

The lesson? Avoid chasing private company shares. You won’t ‘like’ it.

But that’s a case of chasing an IPO before its IPO. What about chasing it during its IPO?

Well, someone asked me a similar question on the Facebook Jam.

And I replied that I hate buying IPOs for the simple reason that I have no control on the price that I have to pay for the business.

The IPO prices are fixed by the promoters and investment bankers, and are 99% of the time on the higher (expensive) side.

Take the oft-repeated case of Reliance Power. A business (was it a ‘business’ anyways?) that had a maximum value of Rs 60 per share (I calculated this purely on the basis of money it was raising, and that was the only value it had), was sold to investors at Rs 450 per share.

The promoter and investment bankers (some really senior and ‘respected’ guys out there) predicted the stock to touch ‘four-figures’ on the listing day. The rest, as they say, is history.

By the way, Reliance Power is just once example (DLF and SKS Microfinance are two other). There are numerous other examples where promoters and investment bankers have priced their IPOs to super-perfection and have gotten away with them…leaving investors high and dry.

The lesson here is – As a rule of thumb, avoid an IPO. Let the hype (or the dust) settle for around six months, study the company if you think the business makes sense, and then take a call.

By this time, you can expect the stock to trade at 40-50% lower price than what it was sold at during the IPO. 🙂

Lesson #3: Rule yourself
Now this is the biggest (positive) lesson I’ve learnt personally from the Facebook IPO.

Like Zuckerberg, rule yourself!

This 28-year old ‘kid’ (who also got married yesterday :-)) has set a strong example of how to chase, accomplish, and live your dream…whatever it is, and whatever it takes.

I’ll close with a quote from Theodore Roosevelt because Facebook and Mark Zuckerberg are daring greatly.

It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.

So as an investor, love to always be ‘in the arena’…striving valiantly, with great enthusiasm and devotion.

You might take it on the chin sometime, and you might be criticized, but that’s fine till you are chasing your dream…your financial freedom.

What say you?

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. I am in the same boat, waiting for the price to come to a reasonable level in stocks like Nestle and CRISIL.

  2. Mansoor says:

    Excellent article Vishalji. For whatever reasons, it is difficult for me to understand investing in Facebook. Although, even during busy times, I pop in to facebook to check few status and hit few likes. It is sort of relaxation for me. But it is difficult for me to understand that they can generate so much business using adverts and because they hold huge data about people, to the extent of 107 times its p/e.
    On the other hand Nestle, Asian Paints, HUL all have tangible assets and they are consumer items which is little easier to accept the fact that they are good brand/business and will grow.
    Can you think of any such company as Facebook in the Indian market?

    • Hi Mansoor, given that Facebook has just reported a profit, their P/E is so high…and it will fall from here. But it is difficult to expect it to fall to such level where it becomes an ‘attractive stock’.

      Well, I named some great listed companies in India (that are better than Facebook in terms of business continuity, tangibility, etc.), though I can’t think of any that comes close to Facebook’s brand appeal, or tells a story like FB does.

  3. Shankar Patil says:

    That was a wonderful article Vishal.
    I have a question..How did you find out that the current price of facebook is 107 times of its P/E? And Reliance Power was worth for Rs 60?? Can you elaborate a bit on this…. I am asking you this to understand the intrinsic value much better…

    • Hi Shankar, thanks for your feedback! Dividing Facebook’s market cap of US$ 104 billion by its net profit figure (which is slightly lower than US$ 1 billion), I get to the P/E of 107x.

      As for the valuation of Reliance Power, I arrived at that value based on a 25 year DCF. Rs 60 was indeed my ‘best-case’ price estimate. 🙂

  4. Technology is a difficult cut throat field. It is ‘mind intensive’ than ‘capital intensive’ and for this reason extremely extremely competitive.
    The decline in Facebook’s share price vs the ipo price is poignant reality (cash flows, investor and banker greed etc).
    Agree with Vishal that preferably stay away from IPO’s since they typically happen when the price (valuation) is quite good and if there is greed in pricing then very limited upside.

  5. Hi Vishal,

    Just awesome. I have been reading most of your posts and commenting for the first time. I am highly impressed by your depth of knowledge and your analysis. Trying to learn a few of them, though it still looks difficult to understand all your criterias before you buy a stock.

    Thanks

  6. people who bought itc,hul ,crisil,colgate,hero in 1980’s and still holding are true followers of warren buffet.so which stocks should one buy in 2012 so in 2040 they would gr0w like hul & colgate etc.please suggest.thank you

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