Facebook Overvaluation Explained By Damodaran

Facebook Overvaluation Explained By Damodaran
Image source: CNBC Video Screenshot

Facebook Overvaluation Explained By Damodaran

Facebook Inc (NASDAQ:FB) on IPO day was a sight to see. The disaster of the company’s offering was both spectacular and disastrous. Everybody has read a hundred times the problems that led to the stock’s blip that day and its subsequent fall but many less have much to say about how the massive overvaluation happened in the first place. For the last month, the firm’s stock had been called overvalued in the press many more times than it had been called a fair buy. How did investors miss the coming disaster?

Many have in the days since the IPO suggested that the overvaluation was a ploy on the part of Facebook Inc (NASDAQ:FB), the Underwriters and the insiders to make a quick buck by tricking retail investors into making bad decisions and getting out at a higher price than the market could have sustained.

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In his op-ed for CNN.com today Aswath Damodaran undermines that view suggesting that it makes little sense for anyone involved. His logic is as such; in the IPO the banks that underwrote it took a big hit to their reputation from the deal and will be unlikely to be offered such an opportunity again any time soon, and the insiders who still retain a large number of shares will not now be able to sell them anywhere near as easily.

Damodaran asserts that the overvaluation was a ploy to dupe small investors but simply a mistake that institutional investors have been making for quite some time. It’s the same thing he saw coming with Apple Inc. stock some weeks back.

Damoradan believes the big investors are basing their valuations less on traditional measures like P/E ratios and revenue growth but more on the actual momentum in the share price. This means that based on the strength in the market of private shares the underwriters were able to decide on an opening price of $38 for Facebook. That price could not have been deduced from the company’s actual performance metrics.

Damoradan paints a cogent and logical argument for the IPO. He casts doubt on the thesis that the mistakes were intentional. He starts from the premise that bankers aren’t evil, something many populists might disagree with, and instead asserts that their nature is incompetence rather than malevolence.

To read Damoradan’s full article head here.

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