Since Facebook's initial public offering (IPO) of $38 was not successful in more ways than one. Shareholders are not only disappointed with the performance of the stock on the NASDAQ, currently juggling between $31 and $32, reports now say that insider information was being circulated amongst "preferred" investors.
Shareholders are launching a class-action suit against Facebook Inc., namely CEO Mark Zuckerberg and CFO David Ebersman, chief underwriter Morgan Stanley & Co., Barclay's Capital Inc, Goldman Sachs & Co., J.P. Morgan Securities, and Merrill Lynch, Pierce, Fenner & Smith Inc.. The suit alleges that underwriters were given inside information regarding the future of Facebook's earnings being reduced due to the increased use of the mobile website and app.
IPOs usually experience a slow and steady growth but that was not the case with this event. But knowing that the revenues could go down and conversely the stock price, underwriters may use this to their own advantage. Short selling or going short means that investors may loan out shares and sell it on to other clients at more or less the current price then payback the stock at a later time. This move is usually done when investors expect that the price will drop.
An example is if you loan a share that's currently priced at $38 and sell it on at the same price, you receive $38. But if the stock price falls to say $32 you only pay back $32; so on the whole you earn $6. This may not sound like much but if you're trading 1000 shares you make $6000 or if you're trading a 1 million shares you make $6 million.
At the start of the whole thing, potential buyers could have spotted the flaw of Facebook's price-earnings ratio (P/E ratio) being ~100:1 as compared to Google, ~18:1, and Apple, ~14:1. P/E ratio usually indicates how much an investor pays to receive 1 unit of net earnings. A lower P/E ratio means that it's cheaper; So long term investors would find several stocks more favorable since they receive more dividends per dollar. It's hard to woo serious investors when dividends are smaller than other companies but short sellers are having a field day with all this.
With a class action suit, falling prices, and relatively lower earnings looming over the heads of Facebook, it's no wonder why it's been in the news a lot lately. But this vicious cycle of negativity forces the stock price even further down which in turn causes even more controversy. Will Facebook be able to recover?
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