08/21/2012 06:15 pm ET Updated Oct 21, 2012

Facebook: Great Social Platform... Bad Investment

The creation of Facebook as a social media platform changed our lives forever. There were great stories of decade old reunions with long-lost friends from high school. Then there was talk about the subscriber base for Facebook approaching one billion subscribers in record time. Everywhere you turned, someone was singing the company's praises.

When the topic of search dominance came up, the consensus was that Facebook would out- muscle Google in this space since it has so much unique information on consumer tastes and preferences. With all of that going for it, an investment in Facebook's IPO seemed certain to return a 50 percent gain as similar investments in technology companies from the year 2000 would do in record time.

Expectations were somewhat met as there has been a 50 percent move in the value of its stock since its IPO. However, that move has been to the downside not up. As of Friday, August 17, 2012 close, Facebook's stock price was hovering right at around $19 a share... a full 50 percent decline from its IPO price in May of 2012. For many that purchased shares of stock at its IPO price, that's been a sure bet on how to lose the money game.

Not all players in the Facebook money game have been losers though. I know of several investors, whose names will not be disclosed for obvious reasons, that profited by selling short shares of the stock after its IPO. Those investors have "show me the money" as their ring tone on their cell phones when you call them. It has indeed been a profitable move for them. So the question is with so much hype following the IPO, what did these investors know that others didn't?

I can assure you that it was not a matter of having insider information as it was a matter of being prudent, wise, and using some common sense. Public information on Facebook indicated that the fundamentals on the company didn't add up. The likely post-IPO market value of $100 billion gave some clues as to what the market was saying each individual with a Facebook page was worth to the company.... about $100.

At face value that might seem reasonable but when you look deeper into Facebook's financials you find that each user only generated about $4 in sales for the company in 2011. That creates a huge vacuum of advertising revenue that would need to be generated to get to the post-IPO valuation numbers. Worse yet, Facebook's advertising revenue actually fell in the first quarter of 2012 from the fourth quarter of 2011.

Another troublesome issue was how the structure of the IPO kept changing right up until the last-minute. And, with each change, it appeared to just get worse for investors. One example of that was the fact that rather than having the normal 180 day lockup provision, which limits how quickly pre-IPO shareholders can sell their shares after the IPO, Facebook's IPO structure had an unusually short lockup period of only 91 days. So if you do the math, it is of no coincidence to me that on Friday, August 19, 2012 the stock reached a new low of $19... approximately 91 days after the IPO on Friday, May 18, 2012.

To add insult to injury, recent reports released in June of 2012 by Reuters and research firm Ipsos, shows that about one in three Facebook users are getting bored with the social network. That does not bode well for the company or its stock. As if that were not enough, Carolyn Everson, Facebook's Vice President of Marketing has been having difficulty winning over skeptical advertising executives who complained that spending on the giant social network wasn't paying off.

So while Facebook was once a great social media platform, both individual and corporate users are calling to question its relevance and the return on investment from using this platform. While those questions are still up in the air, one that isn't at this point is if an investment in its IPO was a good move. Whether it's Facebook or another company, a singular investment in an IPO is usually at best a gamble. Your odds at winning may be better at the slot machine in Vegas. To win the money game, you should invest in fundamentally sound companies that are part of a broadly diversified portfolio. Placing all your chips on one company is a gamble you should avoid.

Apply these principles to help you win the money game!