The debut of the most-hyped IPO in history is about to take place.
Facebook will be going public, and the financial media is salivating all over the news. There have been many warnings about the dangers of buying the stock, but it is important to re-iterate some of the main ones here.
Companies usually go public when their founders want to make a lot of money. They aren't doing it so everyone has the chance to profit.
This fact in itself doesn't mean that it is a bad buy.
However, the fact that CEO Mark Zuckerberg and insiders are selling a large amount of shares is worrying. Unlike prior large tech IPOs, such as Google, many early investors in Facebook are selling their shares to buyers.
Facebook will be a controlled company, with 57 percent of the company in the hands of Zuckerberg. Zuckerberg has been highly praised by many, including Warren Buffett and Bill Gates. However, running a $100 billion company isn't an easy task. For someone who just turned 28, investors are placing their money into the hands of a child.
Facebook is showing signs of a bubble just from discussions with ordinary people. People who know next to nothing about analyzing stocks have asked this author how they can buy the stock. When I warned them about potential dangers, they seemed to be unfazed. This is highly reminiscent of the 1999 tech bubble. There was no happy ending to that story.
Valuations for Facebook are high to say the least. If you buy a store for $1 million and can make $1 million a year, that is a great return. However, with Facebook, you would have to wait 80 years to 100 years just to break even.
Why are people buying? They are expecting growth to catch up and allow them to make their money back quicker. However, the assumptions being used by analysts are nothing short of absurd. I saw reports from analysts who expect 43 percent of the entire population to be using Facebook within a few years. This includes infants and the elderly. The assumptions of future growth and valuations warrant much caution.
Finally, there is competition for Facebook. Although Google-Plus hasn't taken off yet, the social network is still in its infancy.
Google is a very smart company with a lot of cash and a strong market position to eventually make in-roads against Facebook.
Even new companies like Pinterest are already gaining lots of users.
People are buying Facebook because they hear stories of people who bought Apple 10 or 20 years ago or IBM in its early stages. However, these are far more the exception than the rule. No-one brags about buying Atari.
We hope people do make money on the IPO, but hope they have evaluated the many risks involved.
(Disclosure: The author has no position in any securities mentioned.)
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