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Facebook IPO: Reality Check

Stocks in this article: GOOG

You see, the market at a certain point stops thinking about anything but results. The idea that a stock price can only move skyward just evaporates. When it eventually does, a company's value will always be compared to its ability to generate cash earnings.

So take a careful look at what Facebook actually makes and what it earns, and ask yourself what you'd pay to own a piece of that business. At 30% growth a year through the end of 2014, Facebook would have $8.1 billion in revenue and earn $2.2 billion. That level of growth would thrill any reasonable business owner. But at 19.6 times earnings, it means Facebook is worth $43 billion, or 57% less than the top end of its offering price.

4. Assume a Reed Hastings moment.

Everyone likes to talk about what a genius Mark Zuckerberg is. He well may be. But even the greatest tech visionaries make mistakes, and they can be very costly.

Assume the best-case scenario, which is where online movie rental outfit Netflix (NFLX) found itself. Investors had been lulled by consistently good numbers, profitability and sunny outlooks. Then, reality intervened. A mistake was made. And Wall Street remembered that the genius at the helm is fallible, that the company isn't bulletproof, and that all the gains priced into a coveted stock can be erased in the blink of an eye.

This is a Reed Hastings moment.

Hastings is the CEO of Netflix, and he tried to reorganize his company, rebrand it and also raise its prices. It was too much, and subscribers bolted. And shares of Netflix, one of the Internet's great stock-market success stories, tumbled from $300 in July 2011 to about $62 six months later. Now, the good news is that the shares have come back -- they're up more than 100% from their low. But will they gain another $180 a share and retake the heights they once held? Not a chance. Those gains are gone forever. Netflix came back to a diminished reality.

It has to be assumed that the same could happen to Facebook.

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