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Does Social Media Hold Value for Retail Investors?

David Francis

More than a week after its opening, Facebook's initial public offering is roundly considered by Wall Street to be a bust.

It's now clear that the opening $38 price of the stock was inflated, trading glitches caused panic when the stock opened for trading, and the general negativity about the company's long-term ability to produce revenue caused Facebook's shares to fall 16 percent from its opening.

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Both large and small investors who were caught up in the hype of the IPO have lost big. But the Facebook bust hit retail investors especially hard: According to reports, large Wall Street institutional houses had information that the stock was overvalued and were able to make bets accordingly. Retail investors only had information that inflated the stock price.

In the wake of Facebook's disappointing week, many investors are questioning whether other social media companies that are considering going public might be overvalued as well. The rough week for the social media giant could make it difficult for similar companies to pull off profitable IPOs.

Finding investment value in social media. At its most basic, Facebook provides a platform for people to share information with one another. People post photos and videos, share details about their lives, and connect with old friends. Many share links to articles they find interesting. But sharing information does not produce revenue.

[See 4 Ways the IPO Will Change Facebook Forever.]

Perhaps the most-used metric on Wall Street is the price-to-earnings ratio (P/E ratio), which traders use to determine if a stock is properly priced.

It's generally accepted that a healthy company has a P/E ratio of 15 to 25. Overvalued companies typically have a P/E ratio over 40. When Facebook opened, its P/E ratio was more than 100. Now, it's around 85--still ridiculously overvalued by Wall Street standards.

The stock was overpriced for a number of reasons. Many people wanted to own Facebook simply because they are users of the site. But at its core, Facebook's IPO failed because acting as a facilitator of information does not create revenue. One billion people have Facebook accounts, but without a revenue-creating mechanism like charging for access, the number of users is inconsequential.

Too early to pass judgment, but IPO echoes the dot-com bust. Dov Hirsch, senior director of corporate communications for Alana Health Care and a frequent commentator on social media, says one week is not enough time to determine Facebook's long-term value.

"When do you want to cash out? In a year? A month? At the end of the week?" Hirsch asked. "The reality in terms of the value of Facebook is going to be so long-term. Look at General Electric, one of the largest companies in the world. It didn't happen in a week."

[See Some Lessons From the Facebook IPO.]

Hirsh adds that other companies rely on Facebook to spread the word about new products, attract new customers, and build a brand. These uses aren't reflected in Facebook's P/E ratio, but it shows that Facebook has value in the broader economy.

"When you look at Facebook, it's not an independent company. It's carved a huge niche for itself that other people are relying on for their business," he says. "It's created opportunities for others to wrap their business model around and grow in tandem."

According to Nick Westergaard, founder of Brand Driven Social, a marketing firm that helps companies maximize their online brand, the hype around Facebook's IPO and its subsequent bust could make it more difficult for other social media companies like Spotify and Noveo (maker of Angry Birds) to go public. "Is this going to close the IPO window for other social tech companies? I would say it's a push," Westergaard says. "I don't know if it's helped or hindered."

"In a lot of ways, it would be hard to meet such expectations," he says. "I'm not sure it was socially realistic to think the Facebook IPO would have an impact on the broader economy."

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