How to Invest In The Facebook IPO

You almost have to have been living under a rock lately not to know that Facebook is about to become a publicly traded company and issue shares of stock.

Earlier in February, Facebook filed paperwork with the Securities and Exchange Commission (SEC) to start the process of offering shares of stock to investors in an initial public offering (IPO).  But, it will be next to impossible for the average individual investor to get in on the IPO action in the beginning when the stock starts trading.

Investment banks that handle the transactions for Facebook take care of themselves, their best institutional clients, and other mutual funds before regular small investors like you and me are able to buy shares.

Why It Is So Hard For Individual Investors

Investment banks set the IPO price of shares with the company and pre-sell those initial shares before the actual day a company’s common stock hits the market.  When the final offering share price of Facebook is set by Mark Zuckerberg and his investment bankers a day or two before trading begins, it will only be the investment bankers and their best customers who receive those low initial prices.

It is not unusual to see share prices of IPOs jump significantly in the early days after a company goes public.

Groupon’s shares initially soared in November 2011 by as much as 50% on the opening day before settling back down and trading 30% above the original offering price of $20 per share by the end of its first day of trading.

LinkedIn had a very similar fate in May 2011 when LinkedIn’s shares surged 109% from its original IPO share price.

So, how are small individual investors supposed to get in on the ground floor and buy shares of Facebook without paying an arm and a leg?

Using An IPO Mutual Fund Or ETF

There is a mutual fund or an exchange traded fund (ETF) for everything now.

You can find a mutual funds or ETFs to fit any type of investing you want to do.  No longer are you relegated to simply investing in large, mid, and small capitalization domestic and international stocks in your mutual funds.  You have your choice of funds that specialize in such wide ranging and often narrow focused topics as social media, futures of a specific individual commodity like natural gas, biotech, socially responsible investments, specific small countries, and a host of other characteristics.

Luckily, there are also funds that specialize specifically in IPOs.

This is probably the best way for small, individual investors to receive the opportunity to purchase shares of Facebook right out of the gate.  These mutual funds and exchange traded funds such as First Trust US IPO Index Fund (Symbol: FPX), Direxion Long/Short Global IPO Fund (DXIIX), IPO Plus Fund by Renaissance Capital (IPOSX), and others like it are some of those very same institutional clients that the investment bankers work directly with and sell shares to before they are ever available on the open market and to individual investors.

Buying shares in these funds will be one of the only ways that small investors can get in on the early action of the Facebook IPO.

Buying Shares On The Open Market

Once all of the dust has settled and the institutional investors have bought and sold their initial allocation of shares earning their built in profits, then individual investors can have a crack at owning shares in the company that just conducted its IPO.

Since most of the trading with institutional investors are lined up weeks in advance, you should be able to start buying shares of Facebook very soon after they start trading as a publically owned company.

But, will you like the price that you will have to pay?

That is the real question.

There has not been so much excitement for a company issuing shares since Google went public in 2004.  By the time that you find someone willing to sell their shares of Facebook on the very first day of trading, how much will you have to pay for them?  Will it be 100% above the original share price that was set that morning?

Even though so many think that Facebook’s $100 billion market capitalization valuation is over bloated, could we possibly be talking about a $200 billion company on the second day of trading if the price gets bid up considerably?

Should You Even Buy Facebook Right Away?

There have been several financial analysts and bloggers who have come out criticizing investors for their exuberance in wanting to purchase shares of Facebook immediately after the company’s IPO.

Many people worry that Facebook’s estimated $100 billion valuation is simply too high when compared to common financial metrics like its revenue growth and other companies.  Based on the current preliminary S-1 SEC filings, Facebook’s projected $100 billion market capitalization and $3.1 billion in revenue would estimate the company trading at a  26.9 price to sales ratio which is extremely high for a stock in the internet industry.

As a comparison, Google trades at a 5.2 multiple of its annual revenue and Apple trades at 4.5 price to sales ratio.

In fact, Seeking Alpha estimates that Facebook’s valuation should be closer to $56 billion.

If you were to base it strictly off the price to sales ratio, Facebook’s $3.1 billion in revenue last year may actually be worth only about $15 billion in market capitalization which implies a lower share price for Facebook than the one planned is warranted.

If the naysayers are right and the company does not continue its incredible growth we have grown accustomed to, early individual investors who have been clamoring for shares could be in for a nasty surprise in the first few weeks of trading.

[Related: The Best Online Discount Brokers]

To Close

Should you invest in shares of Facebook’s common stock when the company finally goes public later this summer?

Only you can answer that question.

The real question may be, “When will you finally purchase your shares?”  Will you go to your discount broker’s website and pay the current market rate that is sure to be soaring in the first few days?  Or, will you wait to buy your shares when the market has calmed down?

There are other ways to get in on the hot IPO action on opening day.  They just may not be as exciting though.

[Editor: By the way, it’s looking like Facebook’s IPO will release on May 17th or 18th.  Small investors may have a shot a getting shares as well according to the NY Times.]

Hank Coleman is a finance writer who has written extensively for many financial websites and publications in addition to his own blog, Money Q&A. Hank holds a Master’s Degree in Finance and is currently studying to take the Certified Financial Planner exam later this year.