Will FaceBook become Buy & Hedge eligible?

by Wayne Ferbert on May 22nd, 2012

My co-author was on Fox Business this morning talking about how the market has treated Facebook since its IPO. Needless to say, it wasn’t a feel good story. I agree with his assessment that momentum and early news on the company does not support a buying thesis in the short-term.

I am glad that we told all of our clients with ZEGA Financial to avoid it at IPO. Every financial advisor in the country got calls from clients about getting shares of this IPO. But this call was easy for us.

But it made me wonder about what would have to happen to Facebook to make it a buy for Buy & Hedge?

First, options would need to come online for Facebook. CNBC has reported that options will come online for Facebook in the next week. That is a good sign. With a stock with this market cap, the options market will likely be very liquid and have very good open interest.

Investors should also recognize that the options market should help to stabilize the stock price for Facebook. More institutional ownership will come in with the options market for Facebook. So, expect the daily fluctuation in Facebook to get a little more muted after the options come in.

At Buy & Hedge, we like to use options to hedge so the options market has to come online before we’d consider a significant investment.

Lastly, the price is going to need to come in line with value. Personally, I think Facebook has to come down around the $20 to $21 price range to start to look interesting to me.

Let’s remember – this firm’s PE ratio is still over 75x at the $34 price. If the price comes down to $20, the PE would still be 44x. Even if Facebook doubled its earnings over the next 24 months, at the $20 price the PE would finally come back to earth around 22x.

It is a growth story and deserves a premium PE. But the growth is slowing and the demographics of the FB user do not impress me. I think this company needs a couple of stellar earnings releases in the next 2 quarters. Otherwise, I am confident that the $20 price level will be tested.

If you really want to own it around the levels it is trading at today, whatever you do, wait for the options market and make sure you are hedged. This stock is in for an even bumpier ride!

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