Facebook shares will spike to $70 but will it hold?

Facebook’s initial public offering will certainly be the tech IPO of the year if not the decade. Demand is expected to be strong with conflicting reports that institutional demand is weak but everybody agrees that retail demand is more than robust. In a sign of strong demand, the company raised its price range to $34-$38 from $28-$35.

When evaluating stocks there are three approaches investors and speculators take: 1) Fundamental analysis, 2) Technical analysis, and 3) Hope.

Evaluating shares of initial public offerings is no different than shares of any other public company when it comes to fundamentals other than the fact that many new offerings tend to be of companies who are relatively younger than companies who are public already. When it comes to technical analysis, IPOs do not have any trading history which is the backbone of technical analysis. When it comes to hope, there is not a lot of difference except that hope and enthusiasm among investors is very high for overly hyped IPOs. Saying that the Facebook IPO is overly hyped would be an understatement.

So what does this mean for Facebook’s shares once they start trading later this week? Fundamental value investors will shy away because Facebook’s valuation is hard to justify to an investor like Warren Buffett for example. However, there will be many growth investors who will clamor to the stock. Technical and momentum investors will take the initial demand, level of over-subscription, and opening price in consideration and will trade it accordingly. It’s the third category, investors who trade on “hope”, who will be the main culprits in any spike that we will see.

So when Facebook starts trading on Friday May 18, expect the shares to spike above $70 on their first day and possibly reaching $100 in the first hour or two of trading solely because of overanxious investors supported by growth investors who believe that Facebook will substantially grow earnings over the next 5 years. However, don’t expect that level to hold because of the large number of shares being offered – 337 million total – between the shares the company is selling and those being sold by insiders.

When trading IPOs, the number of shares being offered is the most important determinant of how high and how long a first day spike lasts. At the end of the day it is a case of supply and demand and the higher the number of motivated sellers available the less likely a big spike is maintained. The large number of shares being offered will likely make the stock less volatile over the medium term in the days and weeks ahead as it is easier to find an equilibrium price if there are many participants. Hence I do expect a nice spike on the first day to the tune of 100% above the offer price to around $70 or more but expect a price closer to a 50% spike or around $50 to be the more likely price over the medium term.

Tagged NASDAQ:FB, NASDAQ:GOOG