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Facebook: How the Hottest Company in America Became a Cautionary Tale

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"Facebook -- This Time Is Different" might have made for a more attractive title for this piece, but as investors who bought shares of Facebook (Nasdaq: FB  ) on day one found out, sadly enough, that wasn't the case. Over the past several weeks, countless individual investors have learned the hard way that even the hottest of stocks can't defy reality. At the end of the day, overvalued is, well... overvalued. And despite all the losses, the debacle that's become the Facebook IPO isn't all bad, just mostly bad. In sifting through the wreckage, the individual investor can salvage an immensely helpful lesson that goes forgotten all too often from this Hindenburg of a public offering.

Internet 2.0, we've been here before
The last 24 months witnessed the rise of a new slew of Web-based companies that, although probably not on the same scale as the Tech Bubble of the early 2000s, share some uncanny parallels with a period that drove the Nasdaq to nosebleed heights just over a decade ago. Companies such as Yelp (Nasdaq: YELP  ) , Zynga (Nasdaq: ZNGA  ) , and Groupon (Nasdaq: GRPN  ) drew investor acclaim as they made their founders and early investors newly minted millionaires and billionaires. It seemed this new generation of Web-based companies offered huge potential by unlocking the power of crowds. And with the dollar signs often attached to these companies approaching astronomical levels, individual investors' interest was sure to follow, and it did.

As these game-changing companies grew their user bases, they needed additional sources of funding. That's where today's lesson really begins. With investor attention approaching undivided, these new-order companies had no problem raising additional funds by going public. And this worked pretty well for everyone involved for a while. So-called Web 2.0 stocks routinely "popped" sharply upward in price on their first days of trading. Companies like the ones mentioned above were all rewarded with valuations in excess of $1 billion each despite the fact that they were all still unprofitable at the time.

And then there was Facebook
Fast-forward to the earlier this month, and here came Facebook, the poster child for this recent Web bonanza. It seemed as if Facebook could do no wrong. It had changed the world. It has an incredible story behind it. This eight-year-old company had successfully leveraged the Web's potential to provide anyone with an Internet jack the ability to connect with people the world over. What started as a side project in a Harvard bedroom had sprouted into a company so powerful that it helped topple dictatorships. How could it not succeed as an investment, especially since it had been such a good deal for those already involved? Investors were clamoring to get their hands on what was undoubtedly the latest and greatest company. The excitement was palpable.

Fast-forward even further to today, and what seemed like the ultimate golden opportunity has lost much of its shine. Facebook has fallen nearly 30% since its debut, and has become the least successful IPO of the decade among large-cap companies. Those unfortunate to have bought into it are staring at a sea of red. To add insult to injury, a steady stream of news has emerged that's further muddied this debacle of an IPO, and further reinforced the unfortunate perception that the game's rigged against the little guy. Facebook, the golden child that held unknown promise, has now become a cautionary tale.

What's old is new again
More than anything, the entire Facebook saga highlights the emotional biases we deal with as investors. The problem is that for most of us, it's natural to want to take part in the next big thing. It's also that kind of bias that leads people to make dangerous, and all-too-often damaging, investing decisions. This is also part of why most investors, either pros or joes, rarely beat the market over time.

As much as we want to believe it, this time rarely is ever different. And this is exactly why, rather than chasing the hottest trend out there, investors will usually fare better by sticking to the principles of sound investing. It's not fun to say, but it's true. From tulips in the 1600s all the way up to today, investors will keep getting burned chasing the trend du jour. And when you're talking about your nest egg, that's a lesson you never want to learn firsthand. Stick to the Foolish basics of finding great companies you love and holding them for the long term and you'll avoid falling victim to the next cautionary tale.

Andrew Tonner holds no financial position in any of the companies mentioned in this article. You can follow Andrew and all his writing on Twitter at @AndrewTonner.

The Motley Fool owns shares of Facebook. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, 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.

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  • Report this Comment On May 31, 2012, at 4:05 PM, dlagewaa wrote:

    What still bugs me in this whole Facebook thing is that apparently nobody has taken a closer look at the numbers that really matter.

    Sure, Facebook has 900 mio accounts and apparently they can claim that a FB user spends 400 minutes per month on their site. And their managed a 4 billion $ turnover in the last full year. And apparently everybody believes that both the number of users and revenues can only go one way: up.

    With regard to FB users I have a kind of a problem. In my country FB claims 30% penetration, which makes us - relatively speaking - Facebook's second or third largest market.

    My problem is that everybody keeps telling me that everybody USES Facebook. Given that fact that 70 % of the the population does not have an account, this is an exaggeration to start with, but more importantly. Of the 500 people in my network a lot of people tell me they have a FB account, but only very few tell me they actually use it and if they use it it's rarely on a daily basis.

    We ran a small survey amongst users of our online reservation service and we got a similar picture. This tells me that - unless my country is an exception - that there maybe 900 million FB accounts, but there are not 900 FB USERS.

    Another telltale in this respect is the number of 'likes'. At the top of the list in my country is a soccer club with 250.000, the first serious company in the top ten is Samsung with 70.000. But in general most companies in this country have less than 25.000 likes, which is basically a joke. As an example there is a retail chain with about 300 outlets that got 30.000 likes together. Ergo. For most companies The Facebook portion of their clients is just a fraction of their market.

    Facebook may be interesting as an addition to their media mix, but the fate of additions is that they cannot charge premium prices. Consequently it will never get Facebook much further than the current yield of 4,40 $ per user.

    Additionally, in order to milk their client base in low penetration countries Facebook will will have higher marketing cost than in the U.S. which will be detrimental to their profit.

    Than the 400 minutes that Facebook claims their users to spend on FB each month. Those 400 minutes come down to is 10 minutes per day, which is - unless I am mistaken - a fraction of what the average person spends on let's call them traditional media.

    As an advertiser I would ask myself at least two questions: a) how much of that time will the average person spend on advertising in general and how much chance is there that they spend it on my advertising message?

    In my view the answers to these 2 questions will not inspire them to spend lots of money on Facebook.

  • Report this Comment On June 01, 2012, at 1:28 AM, matthewluke wrote:

    Three links to three different newsletter subscriptions in same article (not even counting two customary links at the end of all Fool articles)? Wow. That's a bit excessive, don't you think? Lol.

  • Report this Comment On June 01, 2012, at 11:33 AM, StopPrintinMoney wrote:

    dlagewaa , do you suggest we should start evaluating the tech companies based on the number of minutes spent by an average user? Yeah.... During the dot-com boom the measurement was the "website hits". How did that turn out?

  • Report this Comment On June 01, 2012, at 12:08 PM, dlagewaa wrote:


    No. To the contrary. I just wanted to make clear that the number that was used in the IPO: 400 minutes comes down to 10 minutes a day which does sound a lot less fantastic. Does it.

    As a mediaplanner (and I was one for 20 years) I would want a lot more information before I would consider advising my clients to spend money on Facebook. And I would start with trying to determine the accounts:user ratio.

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