Why I won’t be buying shares in Facebook

published 2 February 2012

It's the moment investment banks have been waiting for.

Facebook is going public. Yesterday, the social networking company announced plans to list on the stock exchange. It's a move that could raise as much as $10bn from investors, and end up valuing the company at $100bn.

This is just the start of the process. The company won't actually be traded until around the middle of the year. But I suspect the Facebook IPO will be a big success. There's too much riding on it for it not to be.

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But I won't be buying in. Here's why

There are loads of reasons to be sceptical about Facebook

I'll admit that when it comes to big flashy tech stocks, MoneyWeek tends to be too sceptical. We weren't keen on buying into Google when it listed at around $85 a share, and the company's huge success has proved us wrong since. And as my colleague Phil Oakley noted earlier this week, we've been too cautious on Apple as well its recent results suggest there's a lot more growth to come.

And my gut feeling is that the Facebook IPO will go down well. It's a big name, there is a huge amount of excitement about it, and I would be surprised if the shares tank when it lists.

Yes, other IPOs in the sector including LinkedIn (the business version of Facebook), Groupon (a discount voucher website), and Zynga (a social gaming company) haven't exactly set the world alight.

But chances are, that's because investors have been saving their pennies to buy into Facebook. After all, the US Securities and Exchange Commission's website almost crashed yesterday as it was overwhelmed by traffic. This listing has been a long time coming, and lots of people want to get in on it.

And sure, you can criticise the fact that Mark Zuckerberg will still be able to do what he wants with the company. The Facebook chief "and his close allies own 57% of the company", as the FT reports. Zuckerberg himself controls 28%. That means shareholders are along for the ride, rather than exercising any influence as owners.

(By the way, if you saw the very enjoyable Facebook film, The Social Network, and went away feeling sorry for his wee pal and co-founder Eduardo Saverin don't worry, Ed's going to be made a billionaire by this float too.)

But this is what you get with visionary technology companies. Google has the same sort of structure. And I'd rather buy stock in a company led by a highly committed, heavily invested founder who cares about his creation, than one that's been hijacked by employees who only care about their next pay packet (yes, I'm talking about the banking sector).

So I think there's every chance Facebook won't disappoint on its IPO.

Investing, not punting

But will I buy it? No. Because investing is not about taking monumental punts on companies which you only vaguely understand. It's about forming a clear understanding of the risks and rewards involved in buying a company, then deciding whether there is enough potential reward to make taking the risk worthwhile.

One undeniable fact about Facebook is that it's already looking very expensive. As Rob Cox of Reuters Breakingviews pointed out, "everyone who's anyone" in investing or Silicon Valley has already "made a killing" off the company by taking private stakes earlier in the company's life. "The worry is that after the investing aristocracy has feasted on Facebook, there's little left for the hoi polloi."

Google, says Cox, went public earlier in its existence, so it hadn't been hawked around as much. To match Google's performance, Facebook "would need to become the world's first $700bn company".

Can it do that? Facebook does make money already. But the argument just as it did in the dotcom bubble still very much hinges on eyeballs'.

Companies' advertising money flows to where their customers are.Google makes money by being the motorway that we all use to traverse the internet. Companies pay to stick billboards on the side of that motorway. And because Google knows what we search for, it can make sure the billboards are particularly relevant to us. That's very attractive.

As far as I can see, this is also the main selling point for Facebook. It gets lots of people using it either to talk to their pals, or to find interesting things on the internet and it advertises to them.

Trouble is, it's harder to monetise' Facebook. That doesn't mean that they won't find a way (although WPP chief executive Sir Martin Sorrell, who should know his stuff when it comes to advertising, is sceptical).

But if you buy Facebook for the long run, you're betting on its ability to make an awful lot more money than it already does, in order to justify its valuation. Given that there are a lot of well-established tech stocks that already make plenty of money, and sport a much lower valuation such as Microsoft (Nasdaq: MSFT), or even Apple (Nasdaq: AAPL) I don't see that the risk / reward balance here is attractive.

This is the nice thing about being a private investor. Lots of index-tracking fund managers, or guys in the tech sector, will right now be suffering painful cognitive dissonance. "I'm not sure this stock is worth it, but I have to buy it, because it's such a big name, and everyone else is going to buy it, and I'll look stupid if it goes up and I don't."

You don't have to care about that. Facebook might go up in value. So what? There are plenty of other stocks out there going up in value too. And better yet, not all of them rely on you taking a flying leap of faith that a brainy 27-year-old will manage to stay ahead of the zeitgeist for the next five years.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.