Is Facebook a Buy at This Price?

No matter where I go or which stocks I am discussing, inevitably I am asked at what price I would purchase shares of Facebook (NASDAQ:FB). Let’s analyze the stock with three relevant sections of our CHEAT SHEET investing framework.

C = Catalyst for a Stockʼs Movement

Now that Facebook has one billion users, the biggest catalyst for stock appreciation is monetization. As I’ve discussed previously, Facebook still hasn’t cracked the code for monetizing their platform in a way which justifies the stocks’ nosebleed valuation. However, if the company can somehow ramp up mobile advertising at breakneck speed, we’d have a catalyst on our hands.

Unfortunately, Facebook’s mobile advertising future is extremely shaky. Anecdotally, I am hearing a chorus of people complaining about the number and types of integrated ads ending up in personal news streams. This is not good news. Rather, it’s an opportunity for an alternative product which limits the commercialization of our personal communications. In the short term, it means Facebook does NOT have a proven, repeatable business model for mobile to support the company’s current valuation. Therefore, I don’t see any reliable catalysts on Facebook’s horizon.

A = A-Level Management Runs the Company

No one can challenge Mark Zuckerberg as one of the all-time greatest startup managers. However, to date, he’s been a horrible public company CEO. Clearly, he didn’t steward the company IPO in a  friendly manner for public investors. Moreover, as a Facebook research note on Business Insider exposes:

Facebook’s dual-class ownership structure is at least as concerning as its board configuration. Mr. Zuckerberg controls about 61 percent of voting shares himself, with insiders and 5 percent holders at nearly 80 percent of vote control. Facebook’s ownership structure gives Mr. Zuckerberg ten votes per share on his Class B holdings while common stock holders have one vote per share. In effect, though the company is now public, Mr. Zuckerberg is ostensibly free to ignore the opinions of common stock shareholders and exert complete control over the company. However, given the management friendly structure of the board, it’s difficult to envision he’ll receive much internal opposition from a board tasked with management oversight.

Zuckerberg might be a product development genius, but he’s definitely not public company ‘A-Level Management’.

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S = Support is Provided By Institutional Investors & Company Insiders

Facebook insiders have been dumping shares like small pox infested blankets:

While Peter Thiel’s $1 billion sell-off was most newsworthy, he wasn’t the only Facebook founder to dump a large batch of shares back on the market this month. Another Facebook co-founder, Dustin Moskovitz, made two separate sales on August 21st and August 24th of 450,000 shares each and was willing to sell for under $20 despite the panicked message such a move sends to the market. With enormous public pressure on the company at the moment, and a halving of the company’s stock price since the IPO, these founders are still willing to sell hundreds of thousands of shares. Facebook’s lock-up period was shorter than that of any of the 40 biggest U.S. technology IPOs since the end of 2010 and insiders have been all too eager to unload these holdings.

Every time I explain this to the average investor who knows nothing about Wall Street, they ask “Why would anyone sell the stock of the most important company in the world?” Herein lies the paradox of investing in public companies: a company’s stock valuation is the combination of many more variables than just whether the product is good. In Facebook’s case, insiders extracted every last drop of value from the equity prior to the IPO. Therefore, once retail demand spiked the stock price and disconnected it from fundamental valuations, the pump was over and insiders knew to dump before the air was let out of the bubble.

Some of Facebook’s insider sales are rational profit-taking. However, the size of these sales proves insiders are not willing to maintain sizable positions with hopes the future will continue providing outsized returns like Google’s (NASDAQ:GOOG) stock did post-IPO. If you need one reason to stay away from Facebook’s stock, this is your smoking gun.

Conclusion

I have been very critical of Facebook’s stock since before the IPO — not because I’m a hater or I have a grudge against Mark Zuckerberg. I actually love Facebook’s product and have perceived tremendous value from it. However, all successful investing begins with using a proven framework for choosing stocks. At this point in time, Facebook continues to defy the core principles Wall St. Cheat Sheet uses to uncover ‘low risk-high reward’ investments. We will have patience as to when Facebook’s valuation and company characteristics warrant serious consideration for an investment of our hard-earned cash. Until then, we continue to focus our attention on much better investment opportunities.

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