Consider the following details from a registration statement that was recently filed with the U.S. Securities and Exchange Commission (SEC):
- The company has a very limited operating history and profits have only been realized during the past three years.
- The primary source of revenues is advertising, but customers are changing to a platform (mobile devices) that the company does not generate any meaningful revenue from.
- Subscriber growth will slow because of the company’s high penetration rates in its current markets.
- The CEO controls the majority of all voting power, including final say over who gets elected to the board of directors. Furthermore, because the company is a “controlled company,” the board of directors does not have to be independent.
- The CEO says his company “was not originally created to be a company” and that he has “always cared primarily about [the company’s] social mission.”
- Last year, the company spent nearly $700,000 on a corporate jet used in part to fly the CEO’s friends and family.
- The company anticipates that a substantial number of shares could be sold up to 18 months following the completion of its initial public offering.
If this was all you knew about the company, would you buy shares in it?
If the company’s name is Facebook (FB), many investors will likely answer “yes.” Depending on the size of the initial public offering (IPO), it is possible that demand will outstrip supply for the IPO shares. Enthusiasm about owning stock in the current “next big thing” will cause some to pass over Facebook’s weaknesses.
Speculative investments always come with risks, but sky-high valuations magnify those risks. Media reports estimate the social networking company could be valued between $75 billion and $100 billion at the time of its IPO. If this estimate holds true (details about the price and the number of shares being offered have not been set), Facebook would rank among the 70 largest publicly traded companies. Furthermore, FB shares would command a price-earnings ratio of 150 and price-to-sales ratio of 27. (The price-earning ratio is based on 2011 net income of $668 million attributable to Class A and Class B shareholders.)
As you can see, there are several negatives about Facebook as an investment. Not mentioned yet are concerns about privacy, Facebook’s inability to penetrate China so far and CEO Mark Zuckerberg’s lack of experience. The last point is particularly worth considering because running a privately held start-up is very different from managing a closely-watched public company that has to report results on a quarterly basis.
Most of the information above came from Facebook’s S-1 filing. This is a registration statement filed with the SEC before a company goes public. You can find significant information about Facebook, or any other soon-to-be public company, by skimming through the S-1 and looking for potential red flags. Be sure to also look at the footnotes, where you will find such things as the jet used by Zuckerberg’s friends and family.
For companies that are already publicly traded, look at Form 10-K. This is an annual report filed with the SEC. Now that year-end numbers are being reported, companies will soon file updated 10-Ks. It is well worth your time to look at these filings, because they may give you reason to think twice about a stock that looks appealing at first glance.
Cutesy of Ecomatters