Facebook IPO: five things to know before buying the stock

About 1 in 8 people on the planet have a Facebook account. Now, with the arrival of a public stock offering, all those people have a chance to be part owners of this social hub.

Can you really buy this stock? Should you?

Here's a glimpse inside the most publicized initial stock offering in years, including some of the things you should be aware of before deciding to buy shares.

Lots of people want to buy this stock when trading starts this week, for a simple reason: Facebook is one of the most visible companies in the world, where Internet technology meets everyday activities like chatting and sharing photos with friends. Now, for the first time, its shares will be traded on public exchanges – offering the chance for people on the outside to own a stake in the company's rapid growth and rich potential.

This won't be the largest initial public offering (IPO) ever, but it is expected to be the largest ever for an Internet company – raising some $12 billion for the firm and its early investors. When Google went public with similar fanfare in 2004, it raised about $1.67 billion.

At the expected offer price between $34 and $38 per share, the Facebook IPO will imply a market value for the whole company close to $100 billion. (That's because much of the stock held by founders and early investors is not being sold to the public.)

But if Facebook will instantly rank among the stock market's largest high-tech companies, that doesn't mean it's automatically a good buy. In fact, amid all the excitement and anticipation, it could be a money loser for incoming investors.

So do some hard thinking before placing a "buy" order. It may be that your Facebook account is a better deal ("It's free and always will be," the firm says).

The five issues covered here will help you think through this investment decision.

1.The insiders are the big winners

A worker inside the Facebook headquarters in Menlo Park, California. Facebook is headed for what may be the biggest IPO in history. (Jeff Chiu/AP)

Remember that when a hot new investment comes to market, the small investor stands last in line. First served by the IPO will be the firm's founders and other investors who took early risks during the start-up phase. They already have a big equity stake in the firm, and they often see the value of their holdings surge as the IPO occurs.

Next at the trough will be financial firms and privileged investors. They can get in at that "offer price" in the neighborhood of $36 per share.

Last, and least, is everyone else.

When trading in Facebook starts on the Nasdaq market under the ticker symbol "FB," financial pros expect the shares to open significantly higher than the official offer price. If that's the case, you'll need to decide whether that higher price feels worth it.

No stock is worth buying 'at any price'

Apple co-founder Steve Wozniak recently told Bloomberg Television: “I would invest in Facebook.... I don’t care what the opening price is.”

That's fine for him to say. He's got lots of cash, and maybe this tech visionary has some good insight on how this IPO will play out. But in general, enthusiastic investors often get burned by taking a great-company-at-any-price view.

Facebook is a great company, in terms of its brand recognition and the massive customer base it has gained since its 2004 founding. To give a sense of its rapid growth, Facebook's revenues, at $3.7 billion, were nearly five times larger in 2011 than they were just two years before.

But the price matters, too. The offering-price range suggests that Facebook will be valued by investors at about 150 times one year's earnings, and at about 25 times annual sales. Both those ratios are extraordinarily high, even for a popular and fast-growing technology firm.

When you buy a share of stock, you're buying ownership of a stream of potential revenues and profits, and you're calculating that that stake will rise in value. Facebook would have to do very well to justify its expected market value. And that's before even counting the price jump that may happen before small investors get a chance to buy.

Maybe the company will execute well. The potential for big earnings growth is certainly there. But financial analyst Henry Blodget flagged a couple of concerns Monday on Yahoo's "Daily Ticker."

Facebook's growth rate is decelerating, "and its profit margins have probably peaked," Mr. Blodget writes. Another challenge, he says, is the increasing share of Facebook activity happening over mobile devices. Ad revenue tends to be smaller in the mobile arena than on traditional computers.

Using data from the firm's stock prospectus, Facebook's revenue grew in 2011 at half the pace of a year earlier, but by a still-strong 88 percent.

If you want a list of other risks the company faces in pursuing its business plan, one good place to start is the company's own stock-offering prospectus, pages 12 through 34. (Every company has to enumerate such risks, so don't let the list automatically scare you off. But read it and ponder.)

Warnings aside, buying an IPO can pay off

Google, the IPO that springs to mind as a rival to Facebook on the hype meter, serves as a reminder that small investors can be winners on a stock's opening day. Google set its offer price with an unusual auction process, and then saw its shares jump more than 17 percent (from $85 per share to $100) on opening day.

Even if an investor bought on that day at $100, the price premium was no barrier to making a profit on the deal. Google shares have risen fivefold since then, although the ticker symbol "GOOG" hasn't been a top performer lately. Those gains all came before recession hit the economy in late 2007.

Technology companies can be volatile investments – great when investors see rapid growth and command of a marketplace. Think Microsoft and Intel in the 1990s or Apple more recently. Facebook could prove to be that kind of company.

Note, though, that dominance for tech firms often fades, and even now many people question the idea that Facebook will have unrivaled clout in social networking. Your own Facebook friends may not click the "like" button on this stock.

Half of Americans view Facebook as a passing fad, according to a new Associated Press/CNBC poll. Among Americans who are investors, 58 percent say the offering price is too high, while about 3 in 10 investors see the IPO as fairly priced.

Mark Zuckerberg says his goal isn't profit

Tucked in the stock prospectus, along with numbers and legal mumbo jumbo, is a "Letter From Mark Zuckerberg," Facebook's chief executive. His message is that he and Facebook have a social mission and that making profits is a secondary goal.

He describes what he calls "a huge need and a huge opportunity to get everyone in the world connected, to give everyone a voice and to help transform society for the future."

Mr. Zuckerberg doesn't disavow the goal of making money, but he says, "we don’t build services to make money; we make money to build better services." That view could rankle many investors who say his Job 1 is to maximize value for shareholders.

But it remains unclear how Zuckerberg and his team will implement his vision. The Facebook co-founder points out that "we have seen disruptive new approaches" in various industries in the Internet age. Pursuit of a mission beyond money could help Facebook be a disruptor and innovator. Or Facebook could see its own franchise disrupted by competitors.

If you really want to own it ...

Investors who feel they can't wait to own Facebook can still hedge their risk in a few ways. One approach is to buy in gradually, not purchase your whole stake on the first trading day.

Second, you can use a "limit order" to avoid paying a higher-than-necessary price. For example, if the stock is trading about $42 per share and you choose to buy with a limit of $41, your purchase will occur when the stock dips to that level.

Third, investment advisers say, it's vital to remain well diversified. Be wary of putting more than a few percentage points of your savings into a single stock, especially one that might be at risk of rising on a tide of untethered emotion.

Finally, remember this: Many diversified mutual funds will soon own the stock, so you can end up with a stake in Facebook even if you don't buy it directly.