Looking to the Past for Facebook's Future

 | Feb 01, 2012 | 11:31 AM EST  | Comments
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Stock quotes in this article:

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rax

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ulta

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lulu

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meli

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goog

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bidu

Amid all the chatter about the potential valuation of Facebook's IPO, and which investment banks will participate in the deal, there's been scant attention to what the launch could mean for individual investors. 

Companies that made their trading debuts in the past 10 or 12 years are generally among the market's best price leaders. For example, Chipotle Mexican Grill (CMG), Rackspace Hosting (RAX), Ulta Salons (ULTA), Lululemon Athletica (LULU) and Mercadolibre (MELI) are examples of current price performers that went public in 2006 or 2007.

From that perspective, I'm a big believer in tracking recent IPOs and maintaining an active watch list of potential buy candidates. But that doesn't mean I lose any sleep over trying to get into an IPO before day one.

The Facebook IPO is drawing comparisons to Google's (GOOG) 2004 debut. Analysts are also looking at the boost in trade that other social media stocks -- also recent IPOs -- got from the Facbook news in recent sessions.

For retail investors, both of those comparisons raise a question about the timing of an IPO purchase. Although there's generally a tremendous amount of hoopla surrounding a high-profile, richly-valued offer, it doesn't necessarily mean investors should jump in immediately. Much of the time, it's prudent to wait for the stock to establish a trading character and undergo its run up and correction.

Google's chart offers a good lesson in IPO trading. The stock made its Nasdaq debut on Aug. 19, 2004, and rallied in its first three sessions. But it reversed sharply off highs that third day, finishing near session lows, as early buyers pocketed some profits.

The stock consolidated for the next three weeks, then resumed its rally, surpassing its previous high on Sept. 15. Volume was lighter that day than in the prior session, which was not ideal. But the bullish price action attracted more buyers in subsequent sessions. The stock just needed a few weeks to flush out early buyers who flipped the stock to grab gains and then it was off to the races.

Google's IPO was as eagerly anticipated at the time as Facebook's is today. Not only did it get plenty of attention from the media and the financial services businesses, but it was an Internet company that had become very popular among consumers. In other words, it was an IPO that everybody and his uncle were talking about.

Sound familiar?

More recently, social media IPOs have tended to be viewed as precursors to Facebook's public launch. However, it's instructive to look at LinkedIn's (LNKD) action since its debut last May 19. The stock was priced at $45, rallied as high as $122.70 in its opening session and closed at $94.25 that day.

As had been predicted, there were plenty of share flippers in the subsequent sessions. The stock attempted a rally in June and July of last year, roughly in tandem with a run up in the broader market. But as major indices came under selling pressure in July, LinkedIn's nascent rally also fizzled.

The stock has yet to regain that $122.70 level and I do not consider it a buy candidate. Of course, the company's business model and valuation are quite different from Facebook's, so I'm not suggesting this is a direct comparison.

But it's yet another reminder of why investors may want to think carefully before trying to grab shares of any new IPO, even something as hot as Facebook. Many investors have become conditioned to the idea of trying to spot the bottom in a stock or an index, but that's a dangerous game.

Do retail investors forfeit some upside potential by waiting for a stock to rally back to levels near its old high? Yes. But they also protect themselves from possible victimization if the big money decides to exit, due to market conditions, company or industry news, profit-taking or other factors.

Although China-based Web portal Baidu (BIDU) has been correcting since July, the stock had a long run as a technical leader. This stock, too, exhibited the familiar pattern of an early pop on its IPO in August, 2005, followed by a correction.

Unlike Google, which was on the radar of most Americans, Baidu was not a widely-known or closely-watched name in the U.S. financial media at that time. Also unlike Google, which rebounded quickly after that initial correction, Baidu meandered along for nearly two years before finally clearing a technical buy point in May, 2007.

I'm not predicting that Facebook will follow the trading patterns established by any individual predecessor, but as a general rule individual investors should not treat an IPO differently than any other stock. That means allowing it to form a proper price consolidation and then buy on strength as it emerges from that base.

That patience allows the early big-money flippers to take some profits, and gives other institutions more of a chance to evaluate the stock and make decisions about weightings within their portfolios. Individuals can then follow the lead of the big investors and purchase on proven strength.

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