Why I’m Ignoring the Facebook Hype

“Time to go to the bank and transfer funds- this Facebook thing is gonna be huge!”These were the words spoken to me by a friend who will be joining the legion of fanatics jumping on board when Facebook IPO’s this week. Call me skeptical, but I just don’t buy into all this hype.

With a projected valuation of over $100 billion, Facebook (FB) would be worth more than either Amazon (AMZN) or McDonald’s (MCD). It has also been reported that 85% of Facebook’s revenue is generated through the use of advertisements (display ads on the site). That is, Facebook makes its money when you click the ads on the site. It doesn’t sell a tangible product, distribute goods, or generate revenue in the way you would expect most traditional companies to. Further, with so much hype surrounding its opening, does it really seem likely that Facebook would represent a value play at this time? That is, would you really be buying in at a low entry point?

Here is a breakdown of reasons why I will be avoiding the Facebook craze:

Does not fit long term portfolio goals:
I am a dividend growth investor, first and foremost. Since Facebook doesn’t pay a dividend, and won’t for the foreseeable future, it fails to meet this important criteria for entry into my portfolio. My long term strategy is to create a portfolio that will generate a growing stream of passive income. In general, I don’t like to fixate on stock prices, which is all I would be doing if I invested in Facebook.

Note: On occasion, I will hold stocks in my portfolio that do not pay dividends, so long as I strongly believe in their future earnings growth (e.g. AAPL, although a dividend was recently announced).

Long term outlook is cloudy at best
What’s the forecast on Facebook’s future? Do you see clear, bright skies ahead? Or thunderous rain clouds sweeping in? The advent of social networking basically began with the birth of Facebook in 2004. Since then, the number of new users has increased exponentially, though one can argue that the popularity of Facebook has now peaked. This is evident by examining the the total number of users – Up to April 2012, there were 900 million users, but the adoption rate of new users being added dwindled to less than 2% increase each month.

See the following chart from Wikipedia:

MySpace, anyone?
Before Facebook even existed, there used to be another popular website just like it – MySpace. MySpace was launched in August of 2003 and reached its peak between 2005 to 2008 when it was the most visited social networking site in the world. At one point, MySpace received more daily traffic than even Google. MySpace’s decline was hastened by the arrival of Facebook (once Facebook allowed registration to all people, and not just college students), as the majority of its users migrated over. To put its decline in perspective, consider that MySpace was acquired in 2005 for $520 million. Six short years later, it was sold off in June 2011 for only 35 million. Does anyone you know still use MySpace? Investing in a social networking company seems to be a very high risk play. Who’s to say the same thing won’t happen to Facebook down the line?

Who really needs who?
It is often argued that investing in companies doesn’t need to be so complicated; to simplify the process, just think of all the things you need to purchase or use on a daily basis. For example, I need to brush my teeth with toothpaste, turn on the lights in my house, go to the grocery store to buy food, etc. Companies like Colgate-Palmolive (CL), Consolidated Edison (ED), and Walmart (WMT) all provide goods or services that I depend on everyday. No matter what happens to the economy, what the latest trends are, or where technology takes us, people will still pony up their hard earned cash to satisfy these basic necessities.

With Facebook, there is no tangible, or physical product to lock you in. You don’t have to use it. Instead, you choose to use it. Whereas I depend on companies like Consolidated Edison to provide me with gas and electricity, Facebook actually depends on ME to sell its advertisements. This works in reverse, and as an investor, this is a scary proposition.

Fierce competition
Facebook needs a large user base in order to be successful and maintain a high valuation. However, competition is fierce- especially when your main rival is Google (GOOG). Google is an innovation company, and could easily come out with new features to steal users away. With so many people already using: gmail, gchat, youtube, etc., it would seem like perfect harmony to marry these tools with a de facto, standard social networking site (Google+).

Summary
In order to have faith in Facebook as an investor, you need to believe that it has a strong economic moat and a stranglehold on its respective industry. It’s hard to imagine a new soda company ever coming along and dethroning Coca-Cola (KO). Or a new railroad company marching into town and putting Union Pacific (UNP) out of business. But it isn’t so far-fetched to imagine the possibility of Facebook someday becoming uncool, losing its popularity, and seeing its user base drastically decline. In fact, we’ve already seen it happen to MySpace.

In fairness, social networking just simply hasn’t been around long enough to show evidence that a dominant leader can emerge and sustain continued success for a long period of time. Facebook may very well be the first company to do so. However, with its user base closing in on saturation, limited year-to-year growth, and the threat of Google looming, its best days may already be behind it. With so many question marks surrounding it (and lack of a dividend), Facebook does not make for a strong investment play at this time.

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FI FighterSix figure investorJW @ AllThingsFinance Recent comment authors
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JW @ AllThingsFinance
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Good choice not to get in so far FI. On day 1, if you would have purchased at the open, you would already be down about $4 or 9% based on an opening price of $42.05 and a close of $38.23.

Also, the media is greatly down playing the NASDAQ problems on opening day. No trades in the first 90 minutes where reported until hours later. None of my clients knew what they purchased the stock at until minutes before the close. Few still haven’t received prices.

Six figure investor
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The bullish case for fb would argue that the site simply isnt a site that sells ads. They are an aggregator of consumer behavior, interests so large in scope that they will become too big too fail (consumers attract advertisers, then companies and advertisers will have no choice but to use fb to give deals and info).

There are thousands of major sites that link up to fb. These partnerships offer the ability to assemble even more info on consumers.

Finally, fb is smart enough to buy out potential new competitors as demonstrated by the purchase of instagram.

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