NEW YORK ( TheStreet) -- As Facebook ( FB) celebrates its first anniversary as a public company, it's worth asking whether it and other social networking sites are favorable investments.
My answer is simple: Right now, they're not. In Facebook's case, it will have to raise earnings or its stock price will have to decline before it becomes an attractive investment. Facebook taught investors so many expensive investing lessons that it's a challenge to know where to begin. I will touch on the main points. The biggest takeaway is that when something is obvious to everyone, you can count on it not happening. Well, it seemed obvious to everyone and his brother that Facebook's initial public offering was a can't-lose investment. When unsophisticated, newly minted investors are opening up their first trading accounts to buy such "sure things," you better step away from the herd.
Everyone I talked to immediately before the IPO asked me about buying shares. I made it clear that I didn't have the slightest interest in buying them and that I would short the stock if I could. (Borrows are not available for retail traders for weeks after an IPO). Lesson: If everyone is buying right now, who are you going to sell to tomorrow at a profit? Valuations do matter. It may seem that traditional valuations are ignored by investors in fast growing companies, but in reality it's always future expectations that are priced in. Relying only on quarterly reports, current price-to-earnings ratios and stock charts is like driving your car using only the rearview mirror. Those are valuable pieces of information for sure, but the future expectations affect the share price, not past performance.
In the case of Facebook, future expectations were ignored because investors were confusing the stock's valuation with the company's valuation. These investors who bought Facebook shares knew and understood the Web site and platform. It's easy and fun to use, and as I wrote in Is Facebook Better Than Sex?, users get a thrill from others "liking" and sharing their content. It may appear reasonable that if a social media company is "liked," the company will produce a reasonable return for investors. If all else is equal, that would be correct, but on Wall Street, rarely is all else equal. Facebook has a P/E ratio of more than 500, and a forward P/E of more than 30. By comparison, the S&P 500 ETF ( SPY) has a P/E of 14.
You may say, "So what Bob. You just said it's the future expectations that matter anyway." You're right, but Facebook isn't a rapidly growing company; it's growth may have peaked. FB Revenue Quarterly data by YCharts