facebook shares – like or dislike?

The success story of facebook globally is astounding. The entrepreneurial ability of Mark Zuckerberg at such a tender age is incredible.  To have started this business a few years ago from his college dorm room and see where it is today is outstanding. As we all know, facebook has changed many people’s lives and connected millions of people in a way never before seen.

 

The company has collectively added to the lives of society.  I saw people on TV last week before the company went public saying how much they “love facebook” and “we use it every day so why not buy shares in it”.

While it is great for connecting us and a good company, is it worth owning part of at the current price?

facebook presents a great lesson in buying shares

The math of the facebook Initial Public Offering (IPO) provides a great lesson for spotting over priced shares.

In round numbers, facebook’s IPO meant that investors were putting $100 billion into a company that has a net profit of $1 billion.  That is, for every $100 invested, facebook investors are only seeing the company earn $1.  And, their capital is not guaranteed to be returned to them in the form of higher share prices.  In fact, facebook’s share price is already down 18% in just a few days of trade.

Doing better in a term deposit
Compare this to the current term deposit rates in Australia, Australian’s can still get about 5% interest on a 12 month term deposit.  That is, for every $100 invested, term depositors are seeing their money earn $5.  Plus, their initial capital of $100 is assured to be there in a year.

What would have been a fair price for Facebook’s IPO?
In round numbers, facebook earn about $1 billion a year.  Considering that investing in shares is riskier than putting your money in the bank, let’s conservatively say that we want to earn twice as much from shares than we could from putting our money in a bank because of the risk involved.  With bank deposit rates at 5%, we want to earn a conservative 10% on our facebook shares.

A very quick back of the envelope calculation suggests that the company earns $1 billion and we are happy to earn 10% on our investment.  Than it stands to reason that if 10% return = $1 billion earnings, the whole company 100% = $10 billion in value.

That’s right, facebook has listed on the NASDAQ for over $100 billion when it is worth about $10 billion. People buying shares have paid ten times what the company is worth.

If the only choice you had with your money was to buy facebook shares at the IPO with a 1% return or an Aussie term deposit with a 5% return, which would you choose?

Will facebook become a dislike?
The facebook IPO has seen the transfer of wealth from the many millions of working class people around the world who parted with their hard earned money to a few already very rich people.  In less than a week since being publicly listed, there are reports of many lawsuits being directed at the company.

With that, do you think facebook has the potential to become the most disliked company in the world?

 

This article is written by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person, nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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