Facebook, Inc.'s (FB) recent IPO has left most retail investors annoyed as some face losses over 20%. Allegations of misbehavior by Wall Street banks and the challenges that NASDAQ experienced last Friday certainly do not help. FB priced its IPO at $38 per share and just closed on Wednesday at $32 a share down 29% off its public high of $45. FB has drawn frequent comparisons to Google, Inc. (GOOG). However, there are also many differences, most notably around size and valuation. The following table shows some high-level comparisons:
| Metric | Units | FB | GOOG | Winner |
| 2011 Revenue | $ Millions | 3,711 | 37,905 | GOOG |
| 2011 Net Income | $ Millions | 1,000 | 9,737 | GOOG |
| 2011 Net Margin | % | 26.9% | 25.7% | FB |
| Market Capitalization | $ Billions | 90.4 | 196.8 | na |
| PE ratio* | x | 90 | 20 | GOOG |
| Balance Sheet Cash and ST investments | $ Billions | ~10 | 49.3 | GOOG |
| 2011 Operating cash - capex | $ Millions | 943 | 11,127 | GOOG |
| Enterprise Value | $ Billions | 80.4 | 147.5 | na |
| EV/Op cash - capex | x | 85 | 13 | GOOG |
| Analyst EPS growth (2012-2013) | % | 27% | 16% | FB |
I think the most startling statistic from this analysis is that there is a large but not huge spread between the EPS growth, despite GOOG's larger size and substantially lower PE ratio. In comparison, the S&P 500 (SPY) trades around a 14x PE ratio. Looking five years into the future, what types of growth would each company have to experience to reach more reasonable PE ratios?
| Year | Net Income ($ Billions) | Growth | Market Cap ($ Billions) | Target Return | PE ratio |
| 2012 | 1.4 | 40% | 90.4 | na | 64.6 |
| 2013 | 1.8 | 27% | 99.4 | 10% | 55.9 |
| 2014 | 2.3 | 27% | 109.4 | 10% | 48.4 |
| 2015 | 2.9 | 27% | 120.3 | 10% | 42.0 |
| 2016 | 3.6 | 27% | 132.4 | 10% | 36.3 |
So based on projected earnings growth, FB's PE ratio would drift down from 62.6x (based on current market cap and estimated 2012 net income) to a more manageable 36.3x by 2016. However that would still be more than twice the current market average. If investors receive no return, the PE ratio would drop to around 24x, which is still higher than GOOG's PE ratio today.
| Year | Net Income ($ Billions) | Growth | Market Cap ($ Billions) | Target Return | PE ratio |
| 2012 | 11.7 | 20% | 196.8 | na | 16.8 |
| 2013 | 13.6 | 16% | 216.5 | 10% | 16.0 |
| 2014 | 15.7 | 16% | 238.1 | 10% | 15.1 |
| 2015 | 17.6 | 12% | 261.9 | 10% | 14.9 |
| 2016 | 19.7 | 12% | 288.1 | 10% | 14.6 |
In contrast, GOOG already trades at a reasonable PE of 20x based on 2011 net income. This is a more modest 40% premium to the market. With 10% returns considered, this premium could essentially vanish over the next five years. In its first five years as a public company, GOOG posted 37% compound annual growth in net income. My assumptions are for some declines from the analyst estimates showing 20% growth followed by 16% growth for 2012 to 2013.
This high-level analysis suggests that FB investors might face limited returns over the next several years as FB grows into its valuation. In contrast, GOOG appears to almost be a bargain given its solid growth prospects, but more importantly its reasonable valuation. Furthermore, on a cash flow basis GOOG appears to be reasonably valued, especially given its substantial balance sheet cash and short-term investments.
A key caution in this analysis is that PE ratios do not necessarily correspond to underlying free cash flow, which provides a more rigorous valuation perspective. Many companies have grown their earnings while cash flow has been disappointing often due to accounting issues or large capital expenditures. A second point would be that as a FB investor or even GOOG investor, I would probably be disappointed with 10% annual returns. Both companies operate in a rapidly evolving space and face substantial upstart competition. FB itself has noted the importance of being on mobile platforms. Internet innovation does not often require substantial capital allowing for a vibrant competitive space.
Conclusion
I had previously written about FB and suggested that it had a significant growth problem. This analysis further suggests that the FB valuation is still quite rich; however, it is not ridiculous. With reasonable performance FB could grow into its valuation; however, this would also be at the expense of high returns for current shareholders. Furthermore, despite more than doubling its net income, GOOG has still not returned to its highs prior to the Great Recession. At this point, I would not consider a long position in FB; however, I think GOOG would merit additional analysis and research.
Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
