With regard to the Facebook scenario, this led to a belief which said that because it had a platform of 900 million users it would be able to leverage this to a degree in terms of advertising and selling opportunities such that the issue price would be sustainable.
The dust had hardly settled on the IPO when the more hard-nosed analysts and investors began demanding detail as to how this platform was going to actually generate revenues. Facebook’s response has been to move into the acquisitions market attempting to snap up other entities through which they could leverage the user base. The extent to which this is successful may well determine whether a floor has been put under the share price or whether there is further downside to come.
None of this seems too complicated and surely one would think obvious prior to the IPO. Unfortunately it was well and truly drowned out by a coalescence of the human traits of self-interest, greed and self-aggrandizement sadly all too familiar in stock markets and never conducive to optimal decision making and effective risk management.
In looking for lessons from this situation, I am reminded of the criticism regularly levelled at ‘old school’ stock valuers like myself during the dotcom boom of a decade ago that we just didn’t understand the new paradigm that was operating. Well history shows that new paradigm was a complete sham then, and what concerns me now is the investment bubble that is building in this space is taking on a similar form.
The one thing I do know from observing investment markets over many years is that these markets have an uncanny ability to repeat the mistakes of the past.
The investors who survive the peaks and troughs in investment markets are those that don’t stray too far from the fundamental investment paradigm that never changes: the price of an equity is a function of risk and return.
So ignore the hype; most of it is designed by players in the IPO game who profit irrespective of the price. Understand the fundamental business model of the company and its strategy and then ask yourself the simple question; is that model and strategy going to deliver a profit and how much am I prepared to pay to get access to those profits?
The writer of this article is Terry Slattery, partner and forensic accountant at DFK.