The hottest IPO in history has come and gone. Facebook debuted last week on the NASDAQ exchange. It has been a very bumpy ride. Non-existent order confirmations, and too many shares brought to market, have created significant questions about the real value of Facebook’s shares. So what is the real value of a share of Facebook, and how is that price determined?
A company’s share price is ultimately the result of supply and demand forces at work. When a stock is in high demand the price will rise. When demand is low or there is an overabundance of supply, the price will drop. So the question then becomes what creates the demand for the stock or a lack thereof? Quite simply, earnings.
In the early stages of a stock’s life, price is driven more by speculation than anything else. Without an earnings track record, analysts have little to go by in determining future cash flows and profits for the company. Ultimately, institutional investors, which provide the bulk of volume on a daily basis, are trying to forecast revenue and earnings growth for the company. Until there have been several earnings reports, we simply don’t know what Facebook’s earnings potentials truly are. And there’s another very important element in analysts’ expectations of the company’s success; the conference call.
During a company’s earnings conference call, key executives review the current financial results. Typically, they also make forward-looking statements about expectations for the coming quarter and the full year. A company can have in-line results, or even exceed expected results, and still see the share price fall dramatically after the conference call. It’s not just about what the executives say about forward-looking expectations, but also the manner in which they answer the analysts’ questions. One doesn’t need to look far to see evidence of this phenomenon. Take for example Cisco Systems, Inc. (ticker CSCO). Time after time the earnings report showed meeting or exceeding expectations yet when the CEO, John Chambers, spoke to analysts during the conference call, the stock would fall in price. Contrast his earnings conference calls to those of Apple Inc. (ticker AAPL) Steve Jobs, and one can see the dramatic difference, and importance, of the conference call. So the question going forward then is whether Mark Zuckerberg will pull a “Chambers” or a “Jobs”?
In the final analysis we simply have no way to measure what is the appropriate value for Facebook shares at this time. It will be at least one quarter and probably two before we begin to see the earnings growth potential of this monster social corporation. Once we have a track record, and after listening to conference calls for several quarters, market forces will be much more accurate in determining the appropriate value for Facebook shares. For now, share price will vary widely as speculators will be driving price movements both bullishly and bearishly. Expect significant volatility in the price of Facebook’s shares in the near-term.
Lastly, for those who prefer to trade options, expect high levels of implied volatility, particularly in the near term options series. High option pricing is expected because of this lack of clarity as to what Facebook is truly worth. In the near-term, Facebook and Facebook options are the realm of the speculative trader. Conservative investors will wait patiently to determine appropriate value and direction of Facebook shares. Me? I’m going to get a bowl of popcorn and sit back and watch the fireworks.
Jeff McAllister
OptionsANIMAL Instructor
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