Lessons Learned From Facebook's Market Misery

Facebook (Nasdaq: FB  ) investors came back from the Hurricane Sandy market break to absorb an unwelcome shot of dilution. Share prices sank 4% on Wednesday as Facebook employees and other insiders saw their call options and restricted stock shares vesting -- meaning that they could sell a few shares for the first time. The 229 million shares that were unlocked for trading represent 12% of the total share count.

As expected, many took the opportunity to do so. On Wednesday, 99 million Facebook shares traded hands, nearly double the stock's average daily trading volume. Wedbush Morgan analyst Michael Pachter noted that many Facebook workers have been "living way above what their salary level would justify," expecting their generous share stashes to make up the difference.

The company reported $1.4 million of stock-based compensation over the last three quarters, which works out to about 56% of Facebook's operating expenses. If nothing else, this event shone a spotlight on the dark side of share-based salaries.

Never mind the fact that share prices have fallen more than 40% since Facebook's long-awaited IPO -- Facebook staffers are regular people with regular problems, like cash crunches forcing them to make some tough selling calls.

Why not bet on another overnight drop?
So the sell-off was hardly a surprise. Does that mean you should bet on further drops as lock-up periods expire in a couple of additional tranches? After all, there's a cool billion new shares floating onto the public market over the next six months. And similar lock-up periods ending have put a world of hurt on other recent IPO darlings:

  • Consumer reviews portal Angie's List (Nasdaq: ANGI  ) plunged 16% when its initial lockup period ended for a massive 44% of the company's shares.

  • Local deals expert Groupon (Nasdaq: GRPN  ) sank 10% when its restricted period expired.

  • Business software vendor Splunk (Nasdaq: SPLK  ) lost just 6% on a similar event last month, but do keep in mind that the stock was in the middle of a downward trend already. Hedge fund manager Zack Buckley slammed the company and stock just two weeks earlier, and reminded the Value Investing Congress that the lock-up expiry was coming soon.

Against this backdrop, it might seem like a foregone conclusion that Facebook will fall further. I don't necessarily disagree that it will, but the lock-up game is not a sure-fire indicator. In fact, you'd have to run counter to some fundamental Foolish tenets to even have a shot at making it work.

Why not? Are you crazy?
Let's say you saw the Facebook event coming at the beginning of last week. "Let me short some stock (or buy some put options) right now," you might have said, "so I don't forget later. What's the worst that could happen?"

Well, Facebook reported surprisingly strong results that Wednesday, and the stock jumped 20% overnight. The lock-up gamble didn't come close to wiping out that sudden gain. Surprises like that can be painful, especially if you're trading with borrowed money and face margin calls on negative events. That's a dangerous way to mismanage your money, and real Fools don't play those games.

Oh, but what if you skipped the earnings-powered jump and placed a bearish bet on Friday? After all, Sandy shut down the markets for two days, removing the option of getting in any closer to the action. Let's just assume that you magically saw what Sandy would do, and acted as late as possible.

Good on you, mate -- you're up 4%. But then, Facebook is an inherently volatile stock that often swings 3% or 4% in a day on no particular news. The expiry gamble is paying off, but hardly in spades.

And then you have to lock in those gains by buying back those borrowed shares as close to the short-term bottom as possible. That means timing the market, guessing whether prices will move up or down in the next five minutes, and generally doing wonders for local Rolaids sales with no guarantees that the gamble will pay off.

We're long-term investors here at the Fool. Our disclosure policy requires us writers to hang on to our market positions for at least 30 days, which completely removes us from crazy schemes like the Facebook gambling I just described. And I'm pretty sure these seemingly artificial trading limits have made me a better investor. Day trading is to roulette wheels as long-term investing is to bank vaults, to borrow phrasing from SAT tests. Facebook just reinforced that lesson for us.

After the world's most hyped IPO turned out to be a dunce, most investors probably don't even want to think about shares of Facebook. But there are things every investor needs to know about this company. We've outlined them in our newest premium research report. There's a lot more to Facebook than meets the eye, so read up on whether there is anything to "like" about it today, and we'll tell you whether we think Facebook deserves a place in your portfolio. Access your report by clicking here.

Fool contributor Anders Bylund holds no position in any company mentioned. Check out Anders' bio and holdings, or follow him on Twitter and Google+. The Motley Fool owns shares of Facebook. The Fool has bought calls on Facebook. Motley Fool newsletter services have recommended buying 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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