If the upcoming initial public offering for Twitter Inc. has you rolling your eyes because of the mess associated with last year's Facebook Inc. debut, consider it a good thing.
Facebook's IPO was a disaster, particularly for small investors who bought shares on the first day of trading, only to see them slide more than 50 per cent over the next three months.
The shares have since recovered, but the bad memories linger. Now that another social media company is readying itself for an appeal to investors, heavy skepticism and knowing sighs are the natural response.
We do learn from experience, though – and the Facebook IPO debacle has taught us several things that will serve investors well as the Twitter temptation builds.
No hype is good hype
Facebook went public amid tremendously upbeat expectations in 2012. It had 900 million users already, and even investors with the most rudimentary math skills could come up with mind-boggling sales and profit estimates in the years to come. When those expectations were challenged, though, the stock sank.
Twitter is keen to avoid this fate. While its user base is massive, the company is determined to keep its financial performance private in the lead-up to the IPO, to help tame the hype. That's good news for investors.
Valuation means something
Facebook shares debuted at a price that was more than 100 times its earnings, or a valuation that recalled the nutty IPOs during the dot-com bubble in the late 1990s.
Optimists can always push aside these uncomfortable comparisons with visions of explosive growth, or with far more upbeat comparisons. For example, they could point to Google Inc., whose shares traded at more than 80 times earnings when they began trading in 2004, and they never suffered for it.
But Facebook was no Google, at least in its first year, and its ridiculous valuation was a big part of the problem – as it is for most stocks with triple-digit price-to-earnings ratios. Will investors fall for a high-priced Twitter stock? Only those with very short memories.
Sell the good news, buy the bad
If the lead-up to Facebook's IPO was dominated by excitement, the months following were dominated by despair. When the share price was cut in half from its debut of $38 (U.S.), one of the biggest sources of this despair was the move by the company's early investors, such as Peter Thiel, to ditch their holdings at the end of various lockup periods – apparently at any cost.
In terms of optics, this wasn't good: Insiders signalled that they could see little future in the stock, discouraging newer investors from holding on. It also fed the belief that Facebook's share price would endure enormous selling pressure for some time.
The stock market works in strange ways, though, and these dark days for Facebook marked the stock's low point, or an ideal time to buy. When Twitter faces its onslaught of bad news, and it likely will, get greedy.
Popular IPOs generate frenzies, to the point where many investors feel they have to get in – and they have to get in fast. In most cases, though, waiting on the sidelines is a far better strategy.
IPOs are notorious for being poor performers soon after their birth, and it's not due to bad luck. Companies usually time their IPOs to capitalize on investor interest, which means that they debut at a peak of enthusiasm.
As Facebook demonstrated, that enthusiasm can fade fast, providing a far better time for investors to jump in. Unless Twitter proves to be a notable exception after its IPO, the pattern will repeat: Giving a pass to the initial excitement will be the best investment decision you will make.