Facebook’s IPO flop holds lessons for small investors

With Facebook shares down 26% from its initial offering price of $38 two weeks ago, opening-day investors are counting the many reasons for unfriending Wall Street.

First, they endured glitches that slowed trading and coincided with a price drop. Then they learned that insiders had talked to each other about potential revenue shortfalls at Facebook. Now they are really mad. Some are even suing.

Small investors have long had reasons to be displeased with the way Wall Street treats them. In 2003, 10 major institutions were caught touting the stocks of companies that were lucrative banking clients — and horrible investment ideas. More recently, small investors have been forced to put up with high-frequency traders, who can destabilize markets with their powerful computers and sophisticated algorithms.

But Facebook’s initial public offering (IPO) is another story. Barring a discovery by the Securities Exchange Commission that Facebook executives gave analysts or underwriters information that went beyond what was in its public filings, the case for outrage is weak.

The first-day trading glitches were certainly a black eye for Facebook and the Nasdaq exchange. But they affected all traders, large and small.

The evidence that small investors were locked out of valuable information is also underwhelming. On May 9, Facebook filed an amendment to its prospectus (a document full of information about a company’s business that it files when selling stocks or bonds).

In it, the company revealed that its revenue growth on mobile devices did not appear to be keeping pace with user growth. Facebook has long faced doubts about its ability to monetize its many users. And here was the company itself confirming this, at least as it pertained to mobile.

Investors buying individual stocks, particularly IPOs, ought to be capable of reading such filings. If they can’t, they should stick to mutual funds and let a pro do it for them. In this case, the late filing was a clear red flag.

Are there better ways to run IPOs? Certainly. In Google’s 2004 offering, the price was set through an open auction process. And several companies are now looking at using the Internet and social media as a platform for stock offerings.

These approaches provide a greater sense of inclusion. But they won’t stop people from buying the hype, failing to do their due diligence, and ignoring warning signs. Only painful losses will put an end to those unfortunate practices. In that regard, the Facebook flop could have positive effects by warning investors of all sizes that IPOs are risky business, not guarantees of quick killings.

Years from now, $28 a share for Facebook, or even $38 a share, might look like a bargain. Or, it might symbolize irrational exuberance for the most highly publicized stock sale of recent years.

For the time being, the main problem of the Facebook offering was this: Too many people paid too much money. Small investors who got shut out of the IPO shouldn’t be angry. They should be thankful.