If you follow any news sources, you have definitely heard about the stock market debut of Facebook, the social networking giant. Although I never give specific recommendations about individual stocks, the IPO of Facebook is a good opportunity to review some basic principles of sound investing.
Facebook became available for purchase to the average retail investor this morning after a long period as a privately held company. The social networking site has over 900 million active members worldwide and is extremely well-known and broadly utilized. For these reasons alone, many people assume that it would make a great investment.
Investing is using money or capital in order to gain profitable returns, such as interest, income, or appreciation in value. How does a share of Facebook fit into this definition? Facebook debuted on the NASDAQ exchange today with a market capitalization (share price x shares outstanding) of over $100 billion, representing approximately 100 times its profits from 2011. Most publicly traded companies trade for 10 to 15 times their annual profits. Facebook shares do not currently pay any income. In order to achieve a profitable return, the share price would have to continue to increase. Anything could happen in the short-run, but a long-term appreciation of Facebook shares is only possible with dramatic increases in revenue and profitability of the company. This will require charges for services that are currently free, additional advertising that could drive away users or other new sources of revenue that don't currently exist. Although I will never claim to predict the future, Facebook has a long ways to go until it pencils out as a sound investment in my view.
Prudent investing requires appropriate assessment of risk, diversification and discipline. Invidividual stocks come with a risk that is too high for most common investors. Diversification requires that an individual own many different types of investments in order to spread risks across various companies, sectors and economies. Discipline is also required to achieve consistent, positive, long-term investment returns. The unpredictability and short-term, emotional movements of individual stocks do not cater to the sound discipline of a prudent investor.
There are other investment considerations that I haven't discussed here, but my simple recommendation would be to use Facebook as the great social networking tool that it is and only use it as an investment in a broadly diversified portfolio.
