By Jack Hough
Facebook’s forthcoming stock offering and United States Treasury notes would seem to occupy opposite ends of the risk-reward spectrum of investments. But the two share similarities.
The 10-year Treasury recently yielded 1.7%, not far from its historic low yield of 1.67% reached in September. Bond yields move opposite prices, so as buyers become more eager, yields fall. Since 1962, 10-year Treasurys carried an average yield of 6.7%.
Facebook set its IPO price at $38 Thursday, suggesting starting market value of $104 billion (shares could easily open higher).The company earned $1 billion last year, a 65% increase from 2010. Assume another 65% increase this year (a bullish assumption, considering that first-quarter earnings declined from a year earlier) and the social networking giant will earn $1.65 billion.
Divide the earnings by the market value and the result is an “earnings yield” of 1.59%–a smidgen below that 10-year Treasury yield. The earnings yield for the S&P 500 index of large U.S companies is close to 8%.
The first similarity between Facebook and Treasurys, in other words, is that they both generate only a trickle of reward for the price.
The ultra-low payoff for T-notes is owed to two main factors. First, the Federal Reserve has kept its core Fed funds rate near zero since December 2008 (and expects to keep it “extraordinarily low” through 2014). Its goal is to spur the economy, and with it, job growth.
Second, investors, spooked by deep fiscal problems in the Euro zone (and a recent anti-austerity movement there) are scrambling for safe havens. The U.S. has fiscal challenges of its own, but Treasurys remain the top choice for stowing large sums of money away from trouble.
The tiny earnings yield for Facebook is owed to a variety of factors, too. The company has widespread recognition among even casual investors, and its initial stock sale is small enough to create a large surplus of demand, pushing prices higher.
But the offering also illustrates that investors are as desperate for growth as they are for safety. Ignore giant earnings increases for prosperous Apple (AAPL) and bailed-out insurer AIG (AIG), and S&P 500 companies produced only about 1% earnings growth during the first quarter.
Neither Facebook shares nor 10-year Treasurys are sure losers, but they are likely ones. Facebook’s stock price could easily soar in the months to come; that’s a function of investor behavior. But in a year or two, absent Apple-like growth, investors are likely to turn their focus to the disparity between the company’s income and stock price.
Treasury investors will get their money back in 10 years and interest along the way, and it’s even possible that yields could move lower and prices higher. (Look at Japan’s 10-year government bond yield of 0.83%.) But the most likely outcome is that the interest fails to keep up with the rising cost of living.
This is plain to see in Treasury Inflation-Protected Securities, or TIPS–a version of Treasurys designed to keep up with the cost of goods and services. Ten-year ones yield -0.35%. In other words, investors who buy them sign up to lose money slowly to inflation. Buyers of regular 10-year Treasurys are signing up for a similar deal stated less explicitly.
Therein lays the second similarity between Facebook and Treasurys. Facebook is an obviously risky investment, but Treasurys, despite their reputation for safety, are risky, too, if they’re all but guaranteed to reduce wealth in years to come.
The broad stock and bond markets still hold opportunity for careful shoppers, but those chasing either extreme of the risk-reward spectrum are unlikely to get their money’s worth.