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May 18, 2012 / 74

Facebook IPO – A leading Indicator of Another Dot.Com Crash?

So Facebook went “public” today. Reading some of the financial blather out there will get you a PE ratio of somewhere around 95 to a bit over 100. Looking up PE ratio will also get you articles that poo poo the importance of PE ratios. So it’s still true – you can find just about anything on the internet. ๐Ÿ™‚

Briefly, a PE ratio (Price to Earnings ratio) does a couple of things. First if there is one, it tells you that the company is actually making some profit. Another thing it tells you is the ratio of the stock price to that profit per share.

And that can tell you something else – which is – if you’re an investor, the PE ratio can be directly converted to “How many years would it take for this company to earn enough profit per share to buy a single share”.

A fast example:

If Facebook’s PE ratio is 95:1, and you buy a share, it will take Facebook 95 years to make enough profit to make that share actually WORTH the stock price in terms of profits made.

When I studied finance we learned that a reasonable PE ratio range is somewhere around 5 or 10, with rare exceptions of 15 IF there are special circumstances that explain the high ratio. ie With a PE of 10, the company will make enough profits in ten years for you to get your investment back in terms of company earnings/increased company value. (Or a net return of 10% of your original investment per year – non-compounding)

Before Dot Com bubble #1 hit we saw PE ratios of as high as 1600:1. Now seriously people. Can you wait 1600 years for these companies to be worth what you paid for the stock? Keep in mind also that these high ratios were during what Greenspaz was talking about when he warned ofย  “Irrational exuberance”. (Dec ’96) A wiki posted this priceless quote about the comment, “The phrase was interpreted as a warning that the market might be somewhat overvalued.” ROTFLMBO!!!!

So now we are seeing PE ratios of 100 (FB), 19.15 (Apple – 2011), & on 12/7/2011 LinkedIn had a PE ratio of 1357.8. There are others, with PE ratios in the hundreds common.

So… is the smart money buying Facebook shares? Not unless they have inside information that guarantees the shares will go higher before they crash! As for me? Hey… I don’t even have a Facebook account. Why would I want their waaaaaay over valued stock?

So I’m going to stick my neck out here and make a prediction – I don’t know where in the run-up to Dot Com Crash #2 we are, ie I don’t know how long it will take for Dot Com Crash #2 to hit, but it sure looks to me like we’re well along the path – and I don’t expect it to take too much longer to get there. Any of you “plungers” out there want to buy a slightly used hard hat?

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3 Comments

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  1. Michael E Picray / Jun 13 2012 21:32

    When I wrote the above it was my opinion that, based on value, the IPO for FB should have been around $6. There are a lot of folks on the internet who just spout off, but don’t make solid statements. Here’s my solid statement.

    Just for grins and giggles, if I had some money to throw away, which I don’t, here’s the bet I’d make today. (I’d sell FB SHORT at $10, settle on or before 12/13/12. (I say $10 because I’d like to leave a little wiggle room. ;-D) But know this too – I’ve never sold a stock short in my life. Also before the nearly 20-year-hold stock I just sold this week (took a bath on it), my long term average ROI was +28%.

    So. Here it is in B&W. If I’m wrong, you can dig into the archives here and throw rocks at me. If I’m RIGHT tho… I’d let you buy me an ice cream cone… (make mine chocolate.) ๐Ÿ˜€

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