Remember the hype about the Facebook IPO? In May 2012, everybody and their grandmother were convinced it would succeed and make everybody rich. As the share price dropped and insiders cashed out, most investors lost a lot of money. Most except for one NYU finance professor who correctly predicted the IPO failure and then bought the stock as it hit rock-bottom.
Some of the NYU’s finance students probably know Aswath Damodaran, who is a professor there. Students in other areas might know him for his textbooks with titles such as “The Dark Side of Valuation.”
Given his academic credentials Mr. Damodaran knows all the theory about financial markets and valuing stocks. With Facebook, he put the theory into practise and made a 100 percent return since last September.
His first valuation before the IPO put the market value at $68 billion, according to his blog. The brokers facilitating the IPO thought otherwise and slapped a $100 billion price tag on the company. This irritated Mr. Damodaran who wrote: “The company and its bankers seemed to assume that they could set the terms for the offering and that the market could go along. In my experience, those who believe that they have power over markets realize otherwise, sooner rather than later.”
They did indeed and underwriters like Morgan Stanley were forced to prop up the share price on the first day of trading so it would not collapse below the IPO price of $38 dollars, costing millions.
Mr. Damodaran, who has nothing against the company in principle, just followed what his valuation models told him. He projected revenues and earnings into the future and discounted the future cash flows with the company’s cost of capital to arrive at a present value of $25.39 per share before the IPO.
After a bad earnings report in July of 2012 he made some more adjustments to his model and reached a valuation of $23.94. He also revised his stance on the company: “I made an argument that the market had over reacted to news and that the earnings reports were not as catastrophic as they were perceived to be,” he wrote in his post.
But Mr. Damodaran knew that the market can override even the most sophisticated models due to sentiment and momentum, so he put in a limit buy order at $18 or 25 percent below his target price. He got “lucky” with that call as the stock hit rock bottom September 4 at $17.58 and his limit order got filled.
“I would love to claim timing precision but it was absolute luck, and I would rather be lucky than good,” he modestly admits on his blog.
As the stock briefly surged above the IPO price July 31, 2013, the recent good earnings report and a higher price are good reasons for Mr. Damodaran to sell again, despite a higher model value of $27.
“Today, I believe that the markets are over reacting again to limited news from an earnings report and pushing the price up too much. As an investor who was lucky enough to buy last [September], because the stock was trading below my estimate of its intrinsic value, I have to be consistent and sell, if the opposite holds now.”