Tuesday, May 29, 2012

Lessons to be Learned From the Facebook Stock Price Fiasco

When Investing, Buy Low, Hang On and Sell High

The hourly, daily, monthly, annual or other price for which a share of stock sells only matters two times to an individual investor: (1) how much it costs per share when he buys it; and (2) how much he receives per share when he sells it.

Thus, Will Rogers accurately advised to buy low and sell high when investing. Makes sense to me.

Buying Facebook Shares

The first step, of course, is the buying. We'll use the current Facebook sorry saga as an example of that simple Will Rogers strategy at work--- buy low and sell high. Will wouldn't have touched Facebook shares with a ten foot pole.

Facebook sold its shares to the public recently at $38 per share and the price per share immediately rose to $43. Those few who bought it at the opening price of $38 and sold a few hours later at up to $43 did well. They weren't investors; they were professional traders.

However, those many people who bought at $38 and didn't immediately bail out have done poorly.  And for those who bought and are still holding on, the worst may be yet to come. It's selling at less than $29 per share today, down almost another 10%.

And those who are buying Facebook today may be trying to "catch a falling knife" by buying at the "low," which is always a dangerous game.

But those who bought previously and are not selling are perhaps playing an even more dangerous game, while telling themselves that they're waiting to sell until they're back to break even. That day may or may not arrive anytime soon, if ever. In fact, some analysts value Facebook shares as low as $13.80.

Now I have no idea what the stock is worth, and I have had absolutely zero interest in buying its shares---whether at the price today, yesterday or tomorrow. But I do know this--people who buy have a hard time selling shares that decline in value, even though that's no reason to continue to own them. A mistake is a mistake.

Thus, don't buy what you're not prepared to own for a long time and don't buy what you can't value at the time you buy. And please don't buy what doesn't represent a great value at the time you buy. That buy-at-a-great-value-price allows you to hold on patiently while the shares are slumping due to general market volatility, a bear market, world chaos or otherwise.

So the first rule of buying is to not overpay, as the Will Rogers school of investing says. Wait instead for either that stock's price  to come down to your "wait 'til price" or buy another stock that has already reached your "wait 'til price."

It's really this simple. Buy and hold works well for those who buy well. Buying well requires patience and effort, which lead to "prior-to-purchase-knowledge" and the ability to hang-in-there-later-when-it's-tough confidence.

Facebook the Company

To repeat, I don't own Facebook stock and never intend to own any. That doesn't mean it's not a great company with a great future. It may well be. But there's a difference between owning a great company at a great price and owning a great company at the wrong price. And we're talking long term investing here. Not short term trading.

You see, long term buyers know that share prices will fluctuate, and sometimes violently, but they also realize that time will be on their side, so they pick the time to buy carefully. Even if they buy periodically, they don't want to overpay for their long term investments.

And with the often severe volatility of the market prices, share prices of good companies sometimes get much cheaper when markets do down. {We'll not take the time to go into why this happens today, but there are very good reasons therefor. Thus, long term investors expect the shares of good companies to go both up and down right along with the bad, and sometimes they go down much faster than the shares of the bad companies when volatile markets move up and down. As market moving professional traders use borrowed money to buy and sell in enormous volumes, that in turn gives us individual investors the opportunity to wait for our pitch to hit. But more on that another time.}

Long Term Investments

Accordingly, my investments are in companies with proven and solid track records, and share purchases are made, albeit infrequently, when the longer term future performance of the company, albeit always somewhat uncertain, appears much better than its current share price reflects.

Accordingly, IPOs (initial public offerings) like Facebook are a no-no investment for boring long term owners like me. These share offerings are often priced in accordance with the greater fool theory of individual investing, meaning simply that there's always a greater fool waiting to buy the stock of the sophisticated trader who is selling. Thus, the seller will make a quick profit and move on to the next trade.

And when trading is the game being played, it doesn't matter how much the "intrinsic value" of the company may be. That means no-no to me.

Other examples of greater fool individual investing are the recent bursting of the housing price bubble and the internet share price bubble in the last decade of the 20th century.

Updating Facebook Saga

Facebook Shares Tumble to Fresh IPO Lows tells the sad story of Facebook's share price development:

"Facebook shares are down more than 5% this morning (now it's closer to 10% down), hitting new lows in the social network’s short history as a publicly traded company. More than an hour into trading, shares are at $30.17 (now at $28.88). . . .

Much has been written about the trading glitches and technical issues that plagued Facebook when it first started trading earlier this month. But as the IPO mania dies down and the stock keeps falling, it’s clear the hype surrounding the stock prior to the IPO has radically shifted from euphoric to bleak.

Walter Zimmerman, senior technical analyst at United-ICAP, points to some of the behavioral finance elements that may be behind the stock’s troubles during its first week and a half of trading.
From the vantage point of behavioral finance the unfolding Facebook IPO fiasco was neither an order flow glitch nor a technical error by the Nasdaq. Nor was the problem a simple share value miscalculation by analysts. All attempts to grasp the Facebook IPO face-plant in these terms is to deal the surface symptoms and to miss the underlying cause.
The Facebook debacle is a textbook case of the collision between human needs and the nature of the financial markets. What went so wrong with this IPO can only be appreciated in terms of the intersection of collective human behavior and finance. The mass psychology of this IPO was that of a classic mania. And that meant a multitude of problems were rendered invisible. We are referring here to two critical and related issues – the timing and the valuation assumptions.
Many Facebook skeptics have gotten a lot of attention in recent days, with the bears biggest point of contention being the hefty valuation. With shares trading at 52 times projected earnings for the next 12 months, according to FactSet Research, the stock is still trading at a higher multiple than many of its peers.

“What happened to the Facebook IPO? Human nature happened,” Zimmerman says. “Crowd behavior can be ugly and dangerous…I would like to suggest that Facebook may be a great signpost, but not a great stock to own.”

Summing Up

Facebook is a great example of both human greed and the greater fool theory of individual investing at work. Following the crowd, especially when buying, can be most dangerous to an individual investor's financial health and well being.

We'll deal with properly valuing stocks in future posts, but for now suffice it to say that emotion is not a good way to determine when to buy and sell--anything. Earnings, cash generation, market position and other factors in relation to share price and overall market valuation are all important factors to consider.

And merely doing what others are doing or recommending that we do is not an important factor. It's not even an unimportant factor. What's in it, if anything, for those urging the buying should always be an important question to ask ourselves before deciding to buy or not buy what's being offered for sale.

Over Time, Stocks are Worthwhile Inflation Hedges and Increase in Real Value.

That's why we own them.

Because we want to keep our buying power intact over time, and that's not going to happen with today's low interest rates, we can't rely on fixed asset investing, including bonds and CDs.

Thus, we have to own stocks and take some well considered risks if we are to maintain and increase the real purchasing power of our money over time.

But those stock ownership risks we do take should be known risks, and we need to do our best to match them with the potential rewards of ownership.

Accordingly, and consistent with preserving and enhancing our dollar's real purchasing power, we want our stocks to provide us with periodic cash dividends and the legitimate potential for ongoing real asset appreciation as well.

That means the first step is to buy low.

Stay tuned. We'll sort this all out over time.

Thanks. Bob.

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