Why Facebook Is the Best IPO Ever

One of the greatest things about life is that you can never stop learning. Sure, it may be harder to learn a new language after college, it may be more difficult to pick up a physical sport after your double knee replacement, and you might find it challenging to pick up developing apps for smartphones in your 80s; but this makes the easy lessons that much more valuable. And the lessons that Facebook’s (Nasdaq: FB  ) highly-visible IPO has given investors are very easy to learn, making it the best IPO for small investors ever. Below are some of the many lessons you should take away from Facebook.

1. Wait until lockup expirations end
After an IPO, there's a set time that insiders have to wait to sell their shares, known as the lockup period. When this period expires, the supply of shares available to sell increases and, just like in Econ 101, when supply increases while demand remains constant, the price will fall. For Facebook, its first lockup expiration released 268 million shares for trading, and sent shares down 6%. Unfortunately for investors, there are several more rounds of lockup expirations, with the largest being on November 14, when 1.2 billion shares will be eligible to trade.

Don’t think that it’s just Facebook. One academic study concludes that a stock price typically drops 1% to 3% when a lockup period ends. A popular example of another lockup sell-off is LinkedIn (NYSE: LNKD  ) . After going public with 8 million shares available to trade, the company closed its first day on the market at $94.25 per share. The week after its lockup expiration, and a secondary offering of shares, which released 32 million shares to be traded, the company hit a low of $59.07 per share.

2. IPOs, on average, perform worse than the market
While Facebook has crashed about 50%, the S&P 500 is up over 8% since the IPO. One study notes that over one year, even after the lockup period expires, stock prices of new IPOs underperform by 0.05% per day compared to similar firms. Over a three year period, new IPOs underperform their peers by 22.4%.

There are, of course, exceptions to this rule. Google (Nasdaq: GOOG  ) debuted at $85 per share, and never closed below $100 per share. It has since handily beat the market by over 500%:

GOOG Total Return Price Chart

GOOG Total Return Price data by YCharts

3. There’s no need to rush into a stock
Because of the poor early performance of IPOs, there’s no reason to jump in right away. Wait until the dust settles, and you can share ownership of the company with more long-term investors instead of short-term focused speculators. Remember that there are no limited-time offers for long-term investors, and that you can always purchase shares in the future. Even if you miss a few percent in a rally, if you believe in the company over the long-term, those few percent will be miniscule compared to the hundreds of percent in returns.

4. Look at others’ incentives
Humans will do what they are incentivized to do. The entire IPO process, especially Facebook’s, is a study in incentives trumping morals. By raising the IPO price of Facebook, and offering more shares, the company was able to raise more cash at an inflated valuation. Banks like lead underwriter Morgan Stanley (NYSE: MS  ) profited to the tune of $100 million from stabilizing Facebook’s stock immediately after its IPO. A few banks had cut future revenue estimates for Facebook, but incentivized by profit, only “selectively disclosed” this information.

As an individual investor, you have to look out for yourself. And you can do this by looking at how other people are incentivized. If a company executive is incentivized to boost earnings per share in order to receive a bonus, there could be a chance he does this through ill-timed share buybacks, or creative accounting. If an executive has little ownership of the company, especially when compared to the salary, this person is not aligned with shareholders, and won’t be working to return the most value to other shareholders. Such incentives and ownership can be found in a company’s annual proxy statement, a document that you should review for each of your holdings.

5. Don’t be afraid to be contrarian
With toddlers, grandmothers, and everyone in between expecting a huge pop for Facebook’s IPO, it stunned the market when shares slid downward. However, those who didn’t breathe in the atmosphere of hype saved themselves from a poor investment. Learning to go against the crowd gives you the opportunity to find bargains for great companies.

Take Amazon.com (Nasdaq: AMZN  ) , for example. With a price-earnings ratio nearing 300, many value investors call the stock overvalued. However, that call happened many times during the stock price’s ascent over the past four years. Meanwhile, you would have more than tripled your investment:

AMZN PE Ratio Chart

AMZN PE Ratio data by YCharts

With the stock down 50%, and with many calling Facebook a horrible investment, it might be the perfect opportunity to be a contrarian investor. For an in-depth look at whether Facebook will be able to succeed, including three key areas to watch, and what risks Facebook faces, check out our brand new premium report. The report also comes with free updates on crucial Facebook news for a year, so grab your copy now!

Fool contributor Dan Newman hopes you learned something from reading this. He holds no position in any of the above companies. Follow him @TMFHelloNewman.

The Motley Fool owns shares of Amazon.com, Google, and Linkedin.
Motley Fool newsletter services have recommended buying shares of Linkedin, Amazon.com, Google, and 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 August 18, 2012, at 11:12 AM, gcp3rd wrote:

    I bet Warren Buffett didn't buy FB. His mindset that he doesn't invest in things he doesn't understand is invaluable insight in my opinion. Of course I understand FB - I have a personal and business page. What I don't understand (admittedly I haven't spent much time trying) is where they are going as a functioning, profitable business. I think they WILL go there (you simply cannot ignore a website with 900 million or so users), but it remains to be seen just how and when. Until that time I won't have money in FB stock.

    Also, wanted to just point out your first rule is really "Always educate yourself about the supply and demand situation". It could be lockups expiring, or other events, but supply vs. demand always affects price.

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