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In Irrational Exuberance, Yale's Robert Shiller looks at the dynamics behind bubbles. "Stories" are one of the key elements -- simple narratives brokers and investors pass on to each other, containing a rationale for participating. The Facebook (Nasdaq: FB ) IPO bubble is no different from any other in that it has been (and continues to be) fueled by a number of stories. It's important to analyze those stories so as not to let shortsightedness and greed sweep you along in their tide, so I'm going to debunk one of them today.
"Buying Facebook now is like buying Google at its IPO!"
This is the structure of the underlying syllogism:
Major premise: Investors who bought shares at Google's (Nasdaq: GOOG ) IPO have done very well.
Minor premise: Facebook is a transformational business, much as Google is.
Conclusion: Investors who buy Facebook shares now will do very well.
The major premise is true, but the minor premise is false (I've already laid out 3 Reasons Facebook Isn't Google). However, even if both premises were true, the conclusion still wouldn't be. It's important to understand why.
The worst investing article I ever read
The most egregious example of this flawed leap of logic I've ever seen was the product of MarketWatch columnist John Dvorak in 2009, trying to justify a plainly ludicrous $20,000 price target for Google. In "Will Google become Microsoft?" he wrote:
I do not see any way of stopping [Google] for at least another decade. It's on the same carnival ride we witnessed with Microsoft (Nasdaq: MSFT ) . Even at today's closing price, Microsoft's stock value essentially has grown by around 200 times since its IPO.
That would mean Google shares could hit the equivalent of $20,000, give or take a few thousand dollars. Of course, Google is in a completely different business using a different strategy. But dominance does have a way of rewarding investors.
The point is that Google has given us only glimpses of its potential, and if we were to equate it with Microsoft, it would be like buying Microsoft stock today for 30 cents to 40 cents a share.
As I remarked privately to a handful of Motley Fool analysts and editors at the time, the author didn't even think to ask whether the two companies had different market values at the time of their respective IPOs! In fact, Google's market value at its IPO price was $23 billion, dwarfing the equivalent value for Microsoft ($519 million) by a factor of nearly 45. Factor that out of Dvorak's 200 times expected return, and you might expect to quadruple your money. That's quite a difference!
A $6 trillion market capitalization?
Here's another way to think about Dvorak's absurd conclusion: Since his premise for Google shares at $20,000 was that Google could "become Microsoft," he might have asked himself why Microsoft itself never achieved a $5 trillion-plus market capitalization -- the value implied for Google if each share were worth $20,000.
There is no sense in extrapolating post-IPO returns from one company to the next when the two come public at completely different valuations, and just as Google came public at a much higher valuation than Microsoft, Facebook came public at a much higher valuation than Google. Let's put some numbers on the Google-Facebook comparison:
|Market capitalization, end of first trading day||$27 billion||$112 billion|
|Current market capitalization||$189 billion||$87 billion|
Sources: Company filings, S&P Capital IQ, Yahoo! Finance.
In other words, if we do a side-by-side comparison of Facebook and Google's market values, the argument suggests that if Facebook's market opportunity turns out to be similar to Google's and if, over the next seven years, it executes as well as the search champion has over the prior seven (both are huge leaps of faith), Facebook can expect to multiply its market value by two (in real terms.)
15% annualized: the impossible dream
That level of value creation would deliver investors with a decent expected return -- if it were a baseline scenario -- but given that this corresponds to a "perfect dream" scenario, it is nowhere near enough to justify the material downside risks attached to more realistic outcomes.
With much less hype, one social-networking company is executing brilliantly on a sounder business model. The Motley Fool's technology analysts think investors should Forget Facebook -- Here's the Social Networking IPO You Should Be Buying.