3 Reasons Facebook Could Be Poised For A Big Year-End Drop

Too many investors expected Facebook, Inc. (FB) to provide instant portfolio gains for anyone who was "lucky" enough to buy at the initial public offering price of $38 per share. It looks like Facebook management and the IPO underwriters became carried away in the media hype that surrounded the company. In the few days before the IPO, the price was raised significantly from about $28 to $38, and so was the supply of shares to be sold. The stock has become one of the worst performing IPOs and it is likely to underperform the markets and even potentially drop further towards the end of the year, for the following reasons:

1. Facebook shares have lost money for many investors and even after a big drop, it's easy to make a case that the stock is still very overvalued. Let's not forget that not long before the IPO, the company was considering a price of $28 per share. The stock is only a couple of dollars below that level, so the shares could still have considerable downside from that perspective. If you consider the performance of other recent offerings like Zynga (ZNGA), which is trading for about half of the IPO price, it isn't unreasonable to suggest that Facebook will follow a similar path, which is to drift much lower.

2. Investors are not willing to pay premium valuations for most stocks, and with market risks remaining high due to the European debt crisis, this trend is probably going to continue. In a major market plunge, companies that are in defensive industries with reasonable valuations, and solid dividends, are likely to hold up better than stocks with sky-high PE ratios. A big market drop could show more vulnerability for this stock. Also, the negative headlines over the lawsuits relating to the IPO are likely to persist for many months.

3. The year-end risk of owning this stock appears high and two factors could keep it under significant pressure. With so many investors losing money in this stock, a large number of them could be looking to sell in the October to December time period so that they can harvest tax losses. Another, big issue that could further exacerbate tax-loss selling is the fact that in about 6 months, an estimated 1.7 billion shares could be released for sale by insiders when their lockup period expires.

That could introduce a flood of shares right around November, which coincides with what could be the peak of tax-loss selling. Investors might be smart to cut losses in this stock sooner rather than later because it's hard to see how a major new supply of shares combined with what could be significant tax-loss selling, will reward investors who patiently wait and hope for a major rebound.

Key Data Points For Facebook From Yahoo Finance:

• Current Share Price: $26.31
• 52-Week Range: $25.52 to $45
• Dividend: none
• 2012 Earnings Estimate: 54 cents per share
• 2013 Earnings Estimate: 66 cents per share
• P/E Ratio: about 54 times earnings

Key Data Points For Zynga From Yahoo Finance:

• Current Share Price: $6.03
• 52-Week Range: $5.51 to $15.91
• Dividend: none
• 2012 Earnings Estimate: 27 cents per share
• 2013 Earnings Estimate: 37 cents per share
• P/E Ratio: about 25 times earnings

Data is sourced from Yahoo Finance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: No guarantees or representations are made. Please consult a financial advisor before making investments.

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