3 Reasons to ignore the fuss over Facebook

John Osbon - May 23, 2012

I think it’s safe to say there’s never been an initial public offering (IPO) quite like Facebook’s. The pre-IPO excitement and buzz were quickly replaced by post-IPO angst and accusations.

The IPO’s price debacle – I’m calling it Faceplant – has revealed many of the flaws and risks inherent in the IPO game. There are plenty of upset investors calling foul and indignant commentators huffing about this unseemly mess. I’m not one of them.  I wasn’t tempted by this IPO and I won’t be tempted by the next one that comes along. Here are three reasons why.

1) Individual stocks carry needless risk

Owning a single stock is the opposite of diversification. You can win big, and you can lose big, even if the market as a whole is relatively calm. (Of course that’s what we’ve seen with FB – a quick, unforeseen and embarrassing rush for the exits.) We don’t want – and I think most investors don’t want – surprises in their portfolios.  That’s why we index.

As an index boutique, the approach we advocate is to own a diversified portfolio of index exchange traded funds representing a mix of asset classes. By doing so, we get diversification twice over: first by owning each ETF, which can have 30-1000 individual securities, and second by owning index ETFs in multiple assets classes, like stocks (large, small, domestic, international), bonds and alternative investments.

We want, and receive, the approximate index return for each asset class.  Putting a big bet on Facebook would be a thrill if it performs like Google (up about 500 points since its IPO in 2004), but there’s no way to know that it will. The risk that it could (continue to) flop as a stock outweighs the small chance that it will quickly double in value, time after time.

2) Too much hype spoils the broth

Anticipation for the IPO has been headline news for months. The phenomenal cultural impact and growth rate of Facebook make it THE business story of 2012, if not the decade. It’s easy to see why, with a user population headed toward one billion. Is it the most astonishing startup ever?  Perhaps.  But is it a good investment? That’s another story.

Great companies – and Facebook may be one – are not necessarily great investments. Despite all its technical innovation, Facebook will need to prove itself the old fashioned way – with earnings. I think many users are pulling for Facebook, but popularity alone doesn’t move the price. Hype is never a good reason to buy a stock. This is a prime example.

3) We’ll own some eventually

Instead of acting on hype, my suggestion is to let the market decide for you…by indexing. Because of its size, the company will likely be part of many indexes and the ETFs that track them. For example, QQQ (the ETF that tracks the 100 largest NASDAQ stocks) can add FB as early as August.*

Instead of placing your own bet on FB, my advice would be to let QQQ, or other index ETFs, do it for you.  If FB goes on to become a stock market star, like Apple, Microsoft, Google or Oracle, you will own an ever larger position in the company as the ETFs build their FB holdings.

That’s one of the features I love about indexes: winning stocks advance in share and the losers disappear. Let Facebook hop into the pool of large cap technology stocks, and sink or swim on its own merits.

*By the way, I would not expect a surge in FB when or if it is added to indexes.  There’s plenty of insider stock eligible for sale: 172 million shares on August 20th, to be exact, and far more in the months that follow.)

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