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Small investors shut out of Facebook IPO, and that's a good thing

Investment frenzies almost never end prettily for the participants.

May 16, 2012|Michael Hiltzik
  • Facebook may be a company with nearly unprecedented potential for growth; the problem with its IPO is that the company will have to experience nearly unprecedented growth to justify its opening price.
Facebook may be a company with nearly unprecedented potential for growth;… (Getty Images )

If you're a small investor seeking a piece of the Facebook initial public offering, here's the bad news: You're too late and you're too poor.

That's the good news too, by the way. Investment frenzies — and stock market veterans have been filling the news media lately with the claim that they've never seen anything like this one — almost never end prettily for the participants.

What may have stoked the flames this time were hints that Facebook or its Wall Street underwriters might crack open a window for small investors, who almost never have a shot at high-profile IPOs. The rationale was that some of the 900 million users who have made Facebook's insiders rich should get a chance to profit from a hot IPO just like the investment bankers, their cronies and their wholly owned mouthpieces on Capitol Hill who usually do.

The excitement grew after E-Trade, a low-commission online brokerage serving retail investors, was added to the roster of Facebook IPO underwriters early this month. (That roster included such usual suspects as Goldman Sachs and Morgan Stanley.) A few days later, it was announced that TDAmeritrade and Charles Schwab, which serve the same segment, would receive allocations of IPO shares for their clients. IPO experts started talking about whether there would be an "altruistic tone" to the structure of the Facebook IPO, as though it were turning into a flower-power $10-billion Wall Street transaction.

Leaving aside for the moment that the truly altruistic step might be to wave the small investor away, it was never in the cards that the average punter would get a smell of the Facebook IPO. Even those online brokerages reserved shares for their very best clients.

TDAmeritrade, for example, says that to bid for a piece of any IPO your account must be worth at least $250,000, or you must have made at least 30 trades in the previous three months. The average TDAmeritrade client holds assets of only $67,400 in his or her account and makes fewer than two trades a month, according to figures in the company's 2011 annual report.

Schwab also imposes asset and activity standards. E-Trade doesn't set an explicit minimum threshold for customers seeking IPO shares, but it does make clear that not everyone is welcome. Interested customers will face a "subjective review" of their account balances, trading history, flipping record and the length of time they've been a customer. The minimum order for the Facebook IPO is 50 shares ($1,700 at the low end of the pricing scale, which was set earlier this week at $34 to $38 per share).

The message at E-Trade, as at TDAmeritrade and Schwab, is that IPOs are reserved for their biggest and most loyal customers — if you opened an account just the other day hoping to snatch up a few shares on the fly, you played it wrong.

Yet how would one play it right? Facebook may be a company with nearly unprecedented potential for growth; the problem with its IPO is that the company will have to experience nearly unprecedented growth to justify its opening price. That's true even at the low end of the scale, which values the entire company at a shade under $100 billion.

Facebook is likely to be the third-largest IPO in history, behind Visa and General Motors. But it's most often compared to the last monster tech IPO, which wasGoogle's2004 offering. That company went public at a price-earnings multiple of just over 40; Facebook is on the path to an opening multiple in the high 60s — that is, its price will be more than 60 times its earnings per share.

The best way to gauge the degree of froth on this latte is to compare it to the current PE multiples of Google and Apple, another company that has earned its stock price the hard way. Google currently trades at a multiple of about 18.5 and Apple at 13.5.

For many would-be investors there's no more point in mentioning the potential pitfalls facing Facebook than there would be warning a teenage boy that the newspaper reviews of "The Avengers" were lukewarm. The pitfalls exist, among them slowing sales growth and obstacles to implementing Facebook's advertising strategy on mobile devices. At least at first, these may not matter to Facebook's stock price because that's not how the stock market operates. To quote Warren Buffett, who was himself misquoting the stock market sage Benjamin Graham: "In the short-run, the market is a voting machine … but in the long-run, the market is a weighing machine." What Graham actually wrote was that the stock market is always a voting machine rather than a weighing machine, but Buffett's version may apply more closely to the Facebook IPO today.

As Buffett explained, voting via the stock market requires only money, "not intelligence or emotional stability." Over time the market filters out emotional frenzy, at least until the next frenzy comes along. When it pauses to catch its breath and take a good hard look at Facebook, where will it peg the firm's value? A few years from now, it may either make hundreds of millions of users still resentful at having been shut out of a sure thing, or breathing the sigh of relief that comes from surviving a close call.

Michael Hiltzik's column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.

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