Why Facebook’s Poor Stock Performance Is A Good Thing For Tech

Facebook’s IPO debuted at $38 only a few months ago, and as of today (August 3), it’s now around $21.  Other well known companies like Groupon, Zynga and Pandora are well down from their IPO prices as well.

This is a good thing, because none of those companies has a proven and sustainable business model to support their IPO valuations.  Facebook has lots of active users, but has to yet to demonstrate how to make enough money to justify a market cap higher than GE or a price to earnings ratio of five times Apple.  For Facebook to justify even its current stock price (almost half of IPO) it would have to grow its revenue at 20-30% per year for years into the future.  Given how saturated the user base has become, this means Facebook has to figure out how to monetize its current user base, do it quickly, and keep doing it for years to come. It’s possible, but I wouldn’t bet much money on it.

The fact that investors recognize this fact and are not buying up Facebook stock just because it’s sexy, shiny, and has lots of users is a very good thing for entrepreneurs.  The late 90s were different – a time when investors routinely ignored the basic premise of a business (make money!) and instead focused on a hopeful future where lots of users automatically equal lots of money.  Investors threw money at anyone with a .com in their name.  Having lots of users can lead to lots of money (see Google, a very fairly priced stock) but not without great technology, good use cases, a solid business plan, and solid execution.  Facebook has good technology, but the business and use cases are still a work in progress, and their execution (particularly in the PR department) has been weak at best.

I don’t dislike Facebook and hope they succeed and do well, but their stock price should sink to a level that makes more sense.  I just feel bad for the non-institutional investors who didn’t do their homework.

When the stock market crashed in 2000, lots of good companies imploded along with all of the bad ones.  We’re far less likely to experience that again if investors pay more attention to fundamentals.  And that means more good small companies will get the money and support they need to become great big companies.