Take one look at Facebook's (NASDAQ: FB) stock price history, and you'll miss an important lesson. The chart below doesn't do it justice, but those who bought in on Facebook's IPO endured a very difficult three-month stretch: The stock lost 50% of its value. Since then, however, shares are up over 550%!
Let's rewind back to the summer of 2012 to cover three very important lessons for investors to remember.
1. You don't need to buy in on the IPO if you want to own the stock... just wait!
Let's review the purpose of an IPO: to raise funds for the company going public. Almost always -- though not without exception -- tons of investors want to get their hands on a previously unavailable stock. That causes a temporary imbalance between supply (shares available) and demand (people who want them), and the stock usually soars on its first day of trading.
But after that, the novelty wears off and prices return to where they should be. Usually, that is the best time to buy.
But things were even weirder in Facebook's case. It didn't need to raise funds. It had over 500 private investors holding shares of the company, and according to SEC rules, Facebook had no choice but to go public.
During the IPO, trading was marred by glitches. The stock was half an hour late to open on May 18, 2012. While it initially popped 18%, it ended the day barely above its IPO price. Just eleven trading days later, it was 33% below this threshold.
Meanwhile, there were stories of individuals who didn't even know how to buy a stock putting their entire life savings behind Facebook. That's insane. They lost one-third of their nest egg in a matter of weeks. This is what the first three months felt like for those investors.
While things have turned out quite well for those who didn't sell, they still would have gotten a much better deal if they didn't feel the need to buy in on the IPO.
2. Be sure you have a sound investing thesis surrounding the business
Too many individual investors were focused on the wrong things when they bought into Facebook -- namely, their personal connection to the service and the movement of Facebook's stock, instead of its business.
While it was exciting to see such a personal service becoming public, it meant next to nothing when it came to profitability.
For years, Mark Zuckerberg relied on outside funding to keep the site going while it was ad-free. Obviously that couldn't continue, but too few investors understood what would have to happen to justify Facebook's market cap.
The second thing too many were focused on was the stock itself. In the first three months of trading, when it was free falling, too few had the patience to wait for Facebook's actual business to announce results -- or even offer up a conference call. They wanted to know why the stock was going down. In reality, it was negative sentiment, and that really had nothing to do with actual business results. Nothing the company reported had changed.
Instead, the smart investor should have been laser-focused on one thing: whether Facebook could effectively offer ads on mobile devices. With it, the company could make a killing. Without it, it wasn't worth anywhere near what it was trading for.
3. Be patient
Of course, even those who knew what to focus on didn't have it easy. In the early days of Facebook, almost all of the money was made on PC ad displays. But as Americans -- and, indeed, the world -- switched to mobile computing, people were openly wondering if ads could really be displayed on such tiny screens.
Barron's magazine went so far as to say that Facebook stock was worth just $15 per share. The analysts were focused on the right thing -- growth in mobile advertising -- they just reached the wrong conclusion. Of course, that was their prerogative, as they said that they "never bought into the pre-IPO hype."
But those who did buy in -- and for the right reasons -- had to show patience for the company to get the mobile advertising platform right. During his first conference call, Zuckerberg made it clear that mobile was the top priority, mentioning the word 27 times in his opening remarks. Since then, here's how mobile revenue has performed.
Notice two things. First, the first quarter has always grown more slowly or even shrunk. That's because the company brings in more in advertising in the holiday season than it does in the dead of winter.
The second is that -- while hindsight is always 20/20 -- an investor didn't even need to be that patient to get results. Between the third quarters of 2012 and 2013, mobile ad revenue grew by over 450%.
The next time you feel like buying a newly IPO'd company, remember to wait, formulate a business-centered thesis, and be patient.