A version of this article originally appeared on Fool.com
WASHINGTON, DC — When the share price for the third-largest IPO in history falls 50% in three months, it can take the enthusiasm for future public offerings out of the market — especially for those in the same nascent industry of social media. And until this enthusiasm returns, and the hype subsides, investors should wait before buying. If there’s one good thing that can come from Facebook‘s (NASDAQ: FB.US) poorly handled IPO, it’s teaching investors that waiting for a few months may not be the worst idea.
For potential Twitter (NYSE: TWTR.US) investors, why not let the jitters shake out and wait until only the truly invested remain owners?
IPO underperformance
Facebook began trading at $38 per share, but bottomed to around $18 a few months later. Not only were questions about its ability to capitalize on mobile revenue swirling, but those who snapped up the stock because of the hype realized that a quick profit was not going to materialize. And, for those who worked at the company, finally allowing an easy transaction from stock to cash on the open market meant diversifying away from the company where they worked or had most of their fortune tied up. For example, co-founder Dustin Moskovitz ended up selling over $130 million worth of stock in August 2012, right around the time the stock was worth the least. It’s the big, long-awaited payoff for many early employees, and waiting until these employees have settled their sales could be the right move when investing in a company like Twitter.
In addition to the hype and insider sales, IPOs, in general, typically underperform. After the lock-up period, when insiders can begin selling shares, a study found stock prices drop 0.05% per day for a year compared to similar stocks. Over three years, IPOs underperform their peers by more than 22%.
Finding the bottom before buying
Of course, you’ll never be able to tell just when the right time to buy is based off the past performance of previous IPOs. For data analytics company Splunk, it was immediately after its lock-up period expired, as I suggested immediately after its IPO. Once the dust settled from its opening week spike to $36 per share, the stock bottomed around $26 per share six months later, and is now up 120% since then to $62 per share. Splunk has yet to post a profit, but the insiders who have wanted to cash out have mostly done so, and those who are betting on the company’s future potential have held on through the hype.
Facebook split up its lock-up expiration dates in order to avoid a one day sell-off. The first few lock-up dates resulted in 6% and 3% drops in Facebook’s share price, while subsequent expirations had less effect. The bottom of Facebook’s share price came after the first big lock-up expiration, but before the rest.
Social media madness
The long-term viability of dominant social networks is still a big question, as the value of such companies depends highly on future prospects that are yet to be proven. In short, these stocks trade on their future stories and hype. When investing in such a stock, take care you don’t invest when that hype is the most positive, because until the business is proven, the stock will trade on such hype for the near-term. And worries like lock-up expirations will drive a negative narrative for the first several months. So, for a company like Twitter, remember that there is no one-time opportunity to buy a truly long-term investment.
