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Jerry Pournelle: On Facebook’s Declining Fortunes

Facebook stock continues to fall.

When Facebook (Nasdaq: FB) first went public in May I guessed that the stock would fall until its price to earnings ratio fell below the P/E for Apple and Google.

A P/E ration is not an exact estimate – particularly because estimating future earnings for any of those companies is not all that accurate a process and it involves a good bit of guesswork. But it is an estimate of what “the market” thinks of the growth potential of the company.

A very high P/E says that the company has very high growth expectations. The objective evidence for the growth potential of Facebook being that much higher than Apple has always been lacking. Why would Facebook come out with a higher P/E than Apple?

I leave conclusions as an exercise for the reader.

It is very clear that those who estimated the initial price of Facebook set it very high, indeed. The price said Facebook would grow faster than either Apple or Google and thus was a better company to hold for growth.

In fact, no one in the market believed that. But it was safe to act as if they believed it because there were a lot of marks out there wanted in.

The stock market over time is not a zero sum game. Many can gain while few are losing. But in an IPO situation with a greatly overpriced initial offering, it is a zero sum game.

Most pros know this. What they need is purchasers to buy at the inflated price first. Then they buy in when the stock has floated down from the heights to a sane price to earnings P/E ratio comparable to and very likely below those of Apple and Google.

Facebook may be innovative and have great growth potential. But it ain’t that much better than Google and Apple. And for that matter, Microsoft ain’t dead yet, either.

Facebook is seeking its true market value and it will find it. Until it does Facebook is a gamble — not an investment. And most all the institutional investors knew this.

I wonder who bought all those overpriced shares? How long did they hold them?

I leave it to the reader to speculate.

Email me at Jerry@anewdomain.net and check out all my stuff at Chaos Manor here.

ED: We at aNewDomain.net wish Jerry Pournelle, who worked with so many of us previously at BYTE, the happiest of birthdays. Dr. Pournelle’s birthday is August 7.

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  • Ant Pruitt

    Happy birthday, Dr. Pournelle!

    -RAP, II

  • Mac McCarthy

    Good points, Jerry, well made. Funny how most of the arguments about FB’s initial offering price neglecting to mention P/E ratios as a basic metric! Highlighting that does help rein in any temptation to grab the stock when it’s “low” — $20 a share isn’t low if it still represents an aggressive P/E.

    And comparing FB to the growth prospects of Google and Apple and, for that matter, the surprisingly strong performance of LinkedIn, brings the discussion down the earth. Thanks!

    And Happy Birthday, Youth.

  • Gina

    HBD Jerry!

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