The world's largest social network is scheduled to deliver earnings this week. Since the Facebook (NASDAQ:FB) IPO in May 2012, the stock price has been on a roller coaster ride. The stock was below $20 in November 2012, and it has since climbed above $32. The unlocking of insider shares during November did not trigger a long-term decline in the stock price. The company is trading at a trailing P/E of 168 and a forward P/E of 49. The market is pricing the stock with an expectation of major growth.
The problem with Facebook is the lack of growth potential. They have captured their first billion Internet users and there are not many left to sign up. The site is banned in China, but popular throughout Europe and the Americas. There is limited scope for increasing the user base. In the developed world, most people who are willing to share their personal information with Facebook already have an account.
Facebook management are trying a variety of new products aimed at broadening the revenue base. They are experimenting with $100 fees to send an email to the CEO's inbox. The company has irritated some users after introducing fees to post to the news feeds of all followers. Conventional email allows users to message friends without a fee. In defiance of this long-standing convention, Facebook wants users to pay for promoted posts when contacting their friends. Finally, Facebook unveiled "Graph Search" which enables searching across the network of friends using keywords. Some controversial search results were posted in the media, although the function is still in beta and not available for most users.
Facebook is stuck in the display advertising business. It seems unlikely that search advertising or email fees will become major revenue streams. The display advertising business is a tough game with stagnant prices and low click through rates on mobile devices. Revenue growth means increasing the volume of ads displayed.
Yahoo (NASDAQ:YHOO) has been a major competitor in display advertising since the 1990s. Yahoo offers many services that are direct competitors for Facebook: photo sharing (Flickr), messaging (Yahoo Messenger and Yahoo Mail), web hosting, e-commerce, games etc. The company has a forward P/E of 17 and sound management under Marissa Mayer. Yahoo search is not banned in China.
Over the years, Yahoo has lost users to Google (NASDAQ:GOOG) and Facebook. Users were turned off by gaudy display ads and gravitated towards sites with a "cleaner" feel. Unfortunately, Facebook is faced with the same problem that Yahoo encountered ten years ago. The post-IPO hype is dwindling, employees want pay rises instead of stock grants and investors are expecting revenue growth. To deliver that growth, Facebook needs to ramp up display ads and introduce more fees. Both are going to turn-off users and encourage them to defect to other sites.
As a value investor, Facebook looks unattractive at the current lofty valuation. Yahoo looks more appealing and probably has similar growth prospects.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.