3 Things Facebook Investors Need to Believe

It's never a good idea to walk into an investment without doing your homework.

A gambler might buy stocks based on gut feelings, simple P/E ratios, or personal experience with a product or service. Taking all of those factors into consideration might land you a decent investment thesis, but just one of them is never enough. Real investors will go far beyond those rudimentary factors.

That's why I want to you think twice before buying into the Facebook IPO, dear Fool.

Even if you've been addicted to status updates and "like" buttons since Facebook's campus-focused early days, that's just not good enough. "But Peter Lynch recommends buying what you know!" some traders might complain. Yes, but the legendary fund manager also told you to dig into financial statements, learn from your mistakes, and worry about what might go wrong. "Know what you own, and know why you own it," Lynch says.

In that Lynchian spirit, here are three questions for any prospective Facebook investor to consider. I wouldn't recommend buying into the social-media leader unless you can answer a resounding "Yes!" to all three of these crucial questions:

1. Do you trust Mark Zuckerberg?
Facebook's founder and leader holds absolute power in the company, with some 57% of the voting power in his hands -- and that heft will probably never go away. In fact, some clever trickery pretty much guarantees that Zuckerberg's heirs -- whoever they may turn out to be -- will control Facebook years after his own death.

The S-1 filing doesn't mince words. In the list of risk factors for Facebook shareholders, you'll learn that Zuckerberg can control the company "in his own interests, which may not always be in the interests of our stockholders generally." And I'm not sure if anybody else in the C-suite would have the temerity to challenge Zuckerberg on whatever day-to-day decisions he wants to make.

So if you want to own this company, you'd better be darn sure you trust Mark Zuckerberg to run it with an iron fist. Remember, he's controlling something you own. You may decide that you're fine with this young entrepreneur running the show, but if that's not how you feel, Facebook shares might as well be lottery tickets.

To be fair, this dictatorial style is hardly unique. Google (Nasdaq: GOOG  ) has been under the absolute control of co-founders Larry Page and Sergei Brin plus Chairman Eric Schmidt since Day 1. The recent introduction of a third class of Google shares didn't change that -- it simply ensures that the top trio's voting power never gets diluted. This always made me queasy as a Google owner, but at least we have three smart people checking off each other's egos and special interests. If any one of them took the voting power singlehandedly, I'd probably sell my shares the same day.

2. Does Facebook have staying power?
You don't want your stocks to do impressions of Icarus, right? The business world is littered with the carcasses of short-lived market darlings that seemed to soar forever -- until they suddenly flamed out in wealth-destroying fireballs. The ride to the top might be nice, but you don't want to be there when the implosion begins.

Let me compare Facebook to Google again. Some might say that Google's search and advertising products are destined to fail when the next upstart builds a better mousetrap. That's how Big G itself got started, pushing out incumbent services like Lycos, AltaVista, and WebCrawler. Indeed, many believe that Facebook and Twittercould replace traditional search engines with the power of crowd-sourced wisdom. And if you believe that, Facebook is probably for you while Google isn't.

But Google has been king of the search engine hill for nearly a decade now, beating back challengers of every kind. Innovative upstarts like Wolfram Alpha find it hard to get a foothold in this ultra-competitive market. IAC/InterActive (Nasdaq: IACI  ) used to be a contender with the personal touch of its Ask Jeeves service, but the rechristened Ask.com hardly matters these days. Even the deep pockets and huge consumer reach of Microsoft (Nasdaq: MSFT  ) can't force its Bing engine down our throats.

Meanwhile, Facebook dominates social networking today, but there are signs that consumers might be getting tired of the service already. There is such a thing as "too much information" about Uncle George feeding his cats, and privacy concerns arise when job interviews or credit ratings hinge on what's in your Facebook account. And in this space, leaders die all the time. MySpace arguably started the market and led it for years. Now, it's a cautionary tale. Are you sure Facebook won't go down the same road to irrelevance?

3. Can Facebook monetize that torrential traffic?
Even if Zuckerberg steers Facebook around every pitfall and keeps the service vibrant forever, none of that matters to investors unless he's making money along the way.

That's not a sure thing. For example, General Motors just pulled its entire $10 million budget for Facebook ads because it says they never made a difference. The world's largest automaker is also one of the most prolific advertisers, and it surely knows a thing or two about pitches that work and pitches that don't. As it turns out, users don't go to Facebook to see sales pitches -- they're there to get social with their friends. Shopping trips to the mall don't necessarily translate into ad-clicking binges on Facebook.

The saving grace here is Facebook's social-gaming platform, with tightly integrated micropayments. Spending money to impress your friends with achievement badges in Farmville or Bejeweled Blitz might sound preposterous, but sector leader Zynga (Nasdaq: ZNGA  ) built its fortune that way. If you answered "yes" to the third question, gaming is probably a big reason why.

The Fool's top analysts just put together a special report on why you should forget Facebook's IPO -- and what you should be buying instead. Grab your copy right now, hot off the digital presses!

Fool contributor Anders Bylund owns shares in Google but holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Microsoft and Google. Motley Fool newsletter services have recommended buying shares of Google, Microsoft, and General Motors, as well as creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (1) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

DocumentId: 1889712, ~/Articles/ArticleHandler.aspx, 4/24/2014 5:15:34 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement