Facebook and Nasdaq: Two Faces of Lost Credibility

Tickers in this article: FB GOOG GRPN LNKD P YHOO

NEW YORK (TheStreet) -- Anytime I come across something that I think is too good to be true, I get nervous. The skeptic in me always seeks to find fault in whatever it is that happens to be the fascination of the day. On Wall Street, that term is called "due diligence."

Although it is often talked about, not everyone appreciates enough the value of sound fundamental research that often leads to the somewhat solitary state of "not believing the hype." This was the case last week with Facebook -- whose hype-filled IPO was full of drama and intrigue leading into the closing bell as it was clear to the entire market that it required a concerted effort from Nasdaq and the company's underwriters to close at $38 in order "to save some face."

It is hard to quantify the level of embarrassment I felt for Facebook as well as the entire market to see what took place in the last 10 minutes of trading as underwriters struggled to keep the stock from ending its first day of trading with a loss. Though the stock managed to close on Friday at $38.23 and keeping it slightly above its IPO price, the methods by which it occurred served as a black eye for a market that continues to deal with notions of manipulative practices.

This became even more apparent on Monday, as the stock closed down 11% to $34.03 on the day that the broader market recovered, which suggests that absent some "influences," Facebook likely would not have closed above $38 on its first day. But this is not because investors were not warned. Instead, investors -- particularly retail investors chose to be greedy when evidence suggested that the right play would have been to be fearful. The question is, what should be the next move?

While greedy investors deserve what they got, they received little help from Wall Street and in particular those that made this IPO the bigger than life event that it was. Investors, particularly those that prefer to spend valuable time on Facebook instead of conducting due diligence on the company, would have seen that it was not a particularly sound investment -- at least not to the extent of how it was sold.

Facebook said recently that it earned more than $1 billion during the first quarter, while also reporting a 12% decline in net income from the year earlier -- declines attributed to an increase in spending. While not entirely a huge concern, it does raise some red flags. But what were the chances that retail investors would know something like this? It probably would not have generated any "likes" if mentioned.

Right now, investors that bought the stock at its high are stuck with it -- there is no way to spin this. The stock likely has already reached its 52-week high and will be range-bound for the next 12 months. That said, Facebook has too much potential to completely abandon the position too soon. However, those that are looking to buy the stock can wait and get in under $30 and possibly $25 as the stock will continue to endure more selling pressure -- particularly from these same weak retail hands who are now dealing with disappointment from expectations that have not been met. Facebook's popularity unlike most stocks presented an easily exploitable base of investors -- the same group that believes a great idea not only should be a great investment, but fundamentals and valuation does not matter.

As it stands, the stock is now trading at a P/E of close to 80 -- not that this is critical at this point for a growing tech company, however, at some point valuations will begin to matter. Wall Street will begin to realize that it makes very little sense for the company to trade at multiple higher than Apple or Amazon while also immediately acquiring a larger market cap than technology bellwether Cisco .

So, will Facebook follow the path of previous overly hyped IPOs such as Pandora or Groupon ? Or will it be able to eventually establish a more successful trading base such as LinkedIn ?

In assessing the direction of the company, one that is without a peer, the prevailing question continues to be, how much is social media worth? Interestingly, as shown by the stock's recent movement, it is clear that the market has just begun to answer this all important question. From the standpoint of value, it is fair to say that Facebook is to social media as Google is to search since at one point Wall Street was forced to answer this same question of both Google and (before it) Yahoo .

In the near term, I suspect that investors will become less enamored with the company's business -- one that will eventually reach the point of saturation. Facebook's challenge will be to find more acquisitions such as Zynga to help offset lost traffic incurred by new faces of competition from those known such as Google+ and from those not yet seen.

Bottom line

It is far too early to predict with any degree of accuracy where Facebook is heading. However, as the company's book is being written, one thing that it has done is rewrite how future IPOs will be constructed and the education that will be required to not suffer a similar embarrassment. That said, it does not mean that Facebook will not be a huge success.

However, I think perspective is something that is often missing on Wall Street when it comes to these perceived "sure things," particularly in the IPO market. From an investment standpoint, I am staying away from Facebook until it drops below $30 and enjoying the fact that this was one call that I had pegged correctly.

Tickers in this article: FB GOOG GRPN LNKD P YHOO