Facebook: Fake Out?

The saying “price is truth” is a popular motto on Wall Street. Analysts and investors can debate until the cows come home about the prospects of a controversial stock, but the share price will ultimately decide who is right and wrong. While Facebook (NASDAQ:FB) has only been trading as a public company for less than three months, its stock price has taken a beating, causing some to admit their mistake and jump ship.

On Friday, Facebook shares climbed more than 5 percent higher along side of a broad market rally, but was it just a dead cat bounce? Prior to the bounce on Friday, shares of Facebook made new record lows for the past three consecutive sessions. The social media giant has been flooded with a wave of negative developments. Facebook recently announced earnings that disappointed investors with slowing growth and no guidance. In a separate report, it even said it believes more than 83 million accounts or 8.7 percent of its 955 million active accounts are fake.

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The price decline in Facebook has caused some major players to dump shares. Two dozen funds from Fidelity Investments purchased a stake of more than $200 million back in 2011. When the Zuckerberg-led company went public, Fidelity purchased even more shares. However, fund managers are now shrinking their stakes. The WSJ reports, “Twenty-one Fidelity funds sold more than 1.9 million public Facebook shares combined in June, with 16 of them selling more than a quarter of their stakes in the company, according to investment-research firm Morningstar Inc. Private shares can’t be traded until later this year.”

If you back out Facebook’s illegitimate users, such as the family pet, the company still has an impressive user base, but investors are demanding more. Facebook still needs to monetize users more efficiently and improve its growth to justify its valuation. If it fails to do so, then investors could easily see more declines in the share price, as seen in social outcast Zynga (NASDAQ:ZNGA). Funds will flow to other social names with more certainty, such as LinkedIn (NYSE:LNKD). The professional networking site reported impressive growth numbers and continues to build revenues through a presence in mobile, an area where Facebook is still lacking. LinkedIn CEO Jeff Weiner explained, “We exited Q2 with 23 percent of unique visiting members coming through mobile apps, versus just 10 percent a year ago.”

Although Facebook shares may appear to be vastly oversold, having touched as low as $19.82 on Thursday, it still trades at a lofty valuation. Based on Wall Street’s current estimate for Facebook’s 2013 earnings of 60 cents per share, it would trade at $6-$7 using a multiple similar to Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG), both of which are still exciting tech stocks. Facebook has huge potential given its amount of users, but if it does not start producing current valuation worthy results, the recent bounce could very well indeed be a dead one.

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