Lessons for Retail Investors From Facebook's Wobbly IPO

May 22, 2012 — -- Facebook shares continued their swoon today, closing another 8.6 percent down after ending yesterday down 11 percent as investors continue to unfriend the stock.

Facebook shares closed Tuesday at $31.12 after briefly reaching $30.94, its lowest yet.

Mark Zuckerberg's shares, which number 503.8 million after he sold 30 million shares in the IPO, lost over $2.1 billion in value in Monday's close of $34.03 from Friday's ending price of $38.23.

Those excited retail investors investors who bought at $45 a share, Facebook's high on Friday, had a rude awakening when the stock opened on Monday below its offer price of $38, and closed at $34.03.

If there's one lesson to be learned from Facebook's IPO letdown, it's don't buy a stock based on emotion, said Bill Middleton, president of Sound Portfolio Advisors of Mystic, Conn.

"This is one of those things built on hype, and they maximized the hype," Middleton said.

Nevertheless, hype is to be expected for a such a widely used consumer product.

"What people forget is that Google went down, too, not from the IPO but down the first week," Middleton said. "So, what you're seeing with Facebook is not completely uncommon. This, though, is a different kettle of fish."

Google was priced at $85 a share at its IPO in 2004, or 74.6 times its earnings, or price-to-earnings ratio.

Shares of the search engine and advertising behemoth, based in Mountain View, Calf., closed up 2.28 percent on Monday to $614.11 a share.

Facebook's IPO price of $38 a share was 100 times its earnings, a high price-to-earnings ratio, even for an eight-year-old company, Middleton said.

"That's a difficult environment, with Microsoft at 10 times earnings," said Middleton. "Exxon is at 10 times its earnings. Even Apple is at 14 times."

Not only was last week a difficult environment for stocks, one of the worst of the year, but Facebook's IPO terms with its underwriters or investment bankers may have also created an unfavorable environment for retail investors.

"Usually, coming off the IPO price, the underwriters try to leave a little room for retail buyers to have a good experience," Middleton said. "Here, Facebook squeezed the underwriters so hard that they squeezed every last penny they possibly could out of the offering price."

Ted Schwartz, president and chief investment officer of Capstone Investment Financial Group and a personal finance columnist, said two older clients approached him a week or so before the IPO about whether they should invest in the social media company.

"They use the site and thought it might be a great investment - that it would soar," he said. "I didn't deny it wouldn't soar in the early days. I was concerned about the longer term."

While untested tech stocks usually appeal to investors with an appetite for risk, Schwartz's clients interested in Facebook were on the "older side," as he describes them, and in retirement.

"They're fairly conservative investors, and it didn't seem like a good fit to me," he said.

Even Schwartz, who said there were fundamental questions about monetizing Facebook's business model, was surprised the stock price had already dropped dropped in its first two days.

"Maybe this indicates investors are getting much smarter and questioning why this would be worth so much," he said.