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The 5 Steps to Trading Facebook

Diary of an IPO Trader

By
Tuesday, May 15th, 2012

It's building...

Can you feel it?

I'm talking about the buzz surrounding the Facebook IPO, which is scheduled for May 18th and will likely be valued around $100 billion.

There are a lot of people on Wall Street who are pooh-poohing the valuation, of course.

They say there is no way Facebook should be valued with a P/E of around 100 when Apple and Google have a P/E of 20 or so.

A P/E, or price to earnings ratio, is a value measure of a stock.

The rule of thumb when you buy a private company like a tire shop or a bakery is that you want to pay five times the yearly earnings. This means you make your money back in five years. Simple.

This varies of course due to things like earnings growth, margins, and debt. But it's a solid place to start.

In public companies, the P/E is higher. The P/E on the Nasdaq is 11.09. The Dow 30 is 13.99.

Google had a P/E ratio of 67.5 when it came out. There were plenty of analysts saying it was too richly valued.

Here's how it did the first four years after its IPO...

goog may 15

You'd take a 500% winner in four years, wouldn't you?

Boom, Boom IPO

Back in the boom days of the dot-com bubble in the late 1990s, every bar and restaurant you went into ran CNBC all the time.

Everyone was talking about how much they made in Yahoo, AOL, and Amazon.

Amazon is the only survivor.

You might be surprised to learn that Amazon's P/E ratio right now is 189!

But I'd imagine you'd take a 1,600% gain over the last decade.

amzn may 15

Today the local pubs and eateries run ESPN. People talk about the mighty Orioles of Baltimore.

They also talk about Facebook: “Saw your thing on Facebook yesterday,” or “Nice pic on Facebook.”

Or how about the ubiquitous “I don't do Facebook.” It's the new “I don't watch TV” for the too-cool-for-school set.

I hear these types of conversations almost every day.

All these people who are on Facebook, almost 1 billion folks (or 15% of the entire human population) know and understand it... at least, they think they do.

And they will buy it — just like people who eat at Chipotle (CMG) bought that stock (P/E 55.82).

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Don't Buy It... Yet

That said, you won't be able to buy it at the expected offer price of $34 to $38 a share. If this IPO follows similar ones, it will be a tough buy for the first six months...

It will launch, sell-off, launch again, and finally after six months — when the insider shares are unlocked — the stock will likely sell off to a buy price.

The SEC makes insiders hold for six months before dumping shares.

Here is a typical IPO chart pattern:

grpn may 15
I used to run a service that played these specific moves.

They repeat — and you can make money from this cycle:

  1. Initial hype, low number of shares in the float send stock up.

  2. The sponsoring broker takes his money out. It's all profit to him.

  3. Run-up into earnings; true believers buying back.

  4. Insiders unlock. They can and do sell shares... Float increases, stock hits low.

  5. Whatever news was held back from the first post-IPO earnings is pushed out in the second quarterly earnings. Stock launches.

My colleague Ian Cooper just made 174% in five days trading this very scenario.

Have a great day,

Christian DeHaemer Signature

Christian DeHaemer

follow basic@TheDailyHammer on Twitter

Since 1995, Christian DeHaemer has specialized in frontier market opportunities. He has traveled extensively and invested in places as varied as Cuba, Mongolia, and Kenya. Chris believes the best way to make money is to get there first with the most. Christian is the founder of Crisis & Opportunity and Managing Director of Wealth Daily. He is also a contributor for Energy & Capital. For more on Christian, see his editor's page.


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