SAN FRANCISCO (MarketWatch) -- Facebook Inc. is still not trading on any kind of rational basis, as the share-price drop triggered by employee selling on Wednesday makes clear.
Among those at Facebook FB) who can finally dump some of their pre-IPO restricted stock units, the prevailing attitude is still a stampede to the door.
That attitude is understandable. The company's workers want to enjoy the same material benefits (albeit on a different scale) as the insiders who've already reaped billions of dollars from the company's success.
But what's good for real-estate agents and car dealers in Silicon Valley is bad news for Facebook retail investors, because this selling pressures the stock price. It's why I've been reminding readers repeatedly to watch for the dates on which large amounts of employee post-IPO lockups expire. Read: Facebook hit again by lockup worries.
Until those dates come and go, positive trading sentiment based on fundamentals is going to be offset by the selling among Facebook insiders -- who got their shares for much cheaper than retail investors.
On Wednesday, the selling was more than enough to counter the bullishness arising from the company's quarterly earnings report, and the shares fell nearly 4%. Come Thursday, the stock is trading slightly higher, up 1% to $21.33.
On Nov. 14, lockups expire on another 800 million shares, more than three times the number of shares that caused this week's drop.
Earnings report good, insider selling bad
It's worth noting that the drop came even though Facebook's most recent financial report was enough to convince Wall Street that the social network will be able to make money off its mobile users.
That may or may not prove true. But either way, the earnings triggered a collective sigh of relief among Facebook bulls and a 20% rise in its shares. The size of that jump suggested that some of the action after earnings was short-covering by traders who'd bet they could ride Facebook straight into the ground.
That's not going to happen, because Facebook has a lot of time and resources to figure out how to grow profits. The question is how big its profit margins will be, because that will determine what kind of valuation its stock will support.
Until the overhang from additional lockup expirations is removed, Facebook shares are not going to reflect its fundamentals alone. It's still trading like an IPO, not an established issue.
This sequence of trading -- with the stock going up on earnings, then down on employee sales -- should be a reminder to public investors just how much of the company is owned by insiders.
It's a reminder that even if Facebook Chief Executive Mark Zuckerberg and his team execute flawlessly, and wring out as much sales and profit growth from their users as possible, the company's per-share profit is going to be significantly and persistently diluted for common shareholders for years.
This is the same reason that the Facebook earnings estimates published by Wall Street analysts are phony in their own way, because they don't reflect the cost of all that equity still held by insiders and employees. Here's a detailed explanation: Read why Wall Street's Facebook estimates are phony.
The phrase "there's no free lunch" may not seem to apply at Facebook, where lunch is indeed free for employees. But it does apply to the company's stock-based compensation program. Every time an worker sells some restricted stock grants, Facebook has to book those expenses on its income statement.
That will lower per-share earnings and cut into the equity value that the company is creating for its common stockholders. In that sense, Wednesday's share price drop can be seen as a preview of the future.
Facebook is a stock that's always going to be a better deal for insiders than for retail investors.
Never underestimate the power of very stupid people in large groups.
