Facebook: The Worst Company Of All Time Indeed?

Jun.13.12 | About: Facebook (FB)

I would have named this article something else…maybe something sounding more positive or upbeat about the newly issued Facebook (NASDAQ:FB) stock, but if I did that I wouldn't really expect to get any readers. After all, about 75-90% of every article I read, segment I see on TV, and "fundamental" analysis of FB is incredibly negative.

Contrary to the title of this article, I will attempt to make a positive case for investing in the most uninvestable company in the market today.

We have all read a myriad of reasons why you or anyone you know shouldn't EVER buy a single share of FB, and how if you did you are: uninformed, irresponsible, unsophisticated, or just plain stupid. The following are just a few reasons that have been discussed on every major news outlet available:

  • FB is (insert adverb here) overvalued
  • FB has no strategy (or a desperate one)
  • FB will be crushed by the competition
  • FB is unable to monetize their user base
  • FB's long term strategic plan is to use operating profits to drown baby kittens (Ok I made that one up, but you get the point.)

Let us first address the valuation argument.

Before I begin, I want to say that I do understand that each person's view is subjective to their own personal opinions, investment philosophy, and risk tolerance, among other things. That being said, I know there are many different ways to "value" a company, DCF analysis, P/E Ratio, Price/Sales, Price/Book, and Price/Cash flow just to name a few. The letters TTM or Forward can be added to any of these metrics, and dozens of others, to derive millions of different opinions on the relative value of a company.

There are countless articles out there that use TTM earnings to compare FB. However, that probably is not the best way to value a growth company. For growth companies, Wall Street generally uses forward P/E ratios for comparison purposes. Based on an average EPS estimate of .54, FB trades a 2012 FW P/E of 50.18, based on the closing price on Friday of 27.10. At the IPO price of 38 that P/E would be 70.37. I know what you are thinking, 50x earnings! 70x Earnings! Who would pay that for anything?! Well let us take a look. Performing a very simple scan for forward P/E on Yahoo for FW P/E ratios > 50 in the S&P 500, Dow, and Nasdaq 100, you will see there are still companies, despite summer doldrums and European woes, that trade at P/Es north of 50x, 98 to be exact. Rather than naming all of them I will name a few for comparison purposes.

Stock Fw P/E PEG
FB 50.18 1.36
Amazon- (NASDAQ:AMZN) 84.81 5.45
Salesforce.com-(NYSE:CRM) 68.46 6.11
LinkedIn-(NYSE:LNKD) 77.16 2.16
NRG Energy-(NYSE:NRG) 143.82 1.79
Netsuite-(NYSE:N) 138.94 6.32
Fusion-Io-(NYSE:FIO) 59.69 1.86
Zipcar-(ZIP) 59.91 1.58
Click to enlarge

(All data retrieved using Yahoo Inc Stock Screener)

So you see this valuation argument, while valid for some investment methods, doesn't really hold up for those investors seeking growth or innovation. So why would an investment firm pay such a rich valuation for a company? The answer is simple, potential. With the companies above, as well as the other 98 on the list, extreme P/Es are accepted because investors see great potential in these companies. Justified or not, these are the perceived values of the collective investment community. Let us not forget that it was the global investment community that allowed this 38 issue price to become accepted. In my opinion, the problem with the precipitous drop in FB shares comes from the short interest created by institutional investors (another topic for another article).

Another popular valuation for growth companies is the PEG ratio. The PEG ratio above is derived from the estimated 5 year growth rate. As you can see not only does FB trade at a comparable P/E ratio to these other growth companies, but it also trades at a fairly modest PEG ratio when compared to others. It is not uncommon for a growth play to trade at 1-2X their growth rate. FB falls within this range, which is not outrageous by any means.

There are countless doubts about the company's strategy going forward regarding the future of mobile, growth rate, and monetization of the user base, but the truth is these answers can only be derived from conversations with company insiders. Investors speculate on the future intentions and execution of the company once management articulates a strategy. With the one of a kind active user base that FB possesses, a simple shift in strategy, or innovation, or introduction of a new product could possibly have a dramatic impact on the earnings power, and growth of the company. This is surely what believers in the FB story are investing in. In my opinion, any arguments relating to these issues are strictly relative, as each investor has the right to derive their own conclusion on whether or not they believe in the business model and the strategic direction of the company.

One thing is clear, Facebook is a unique company, with a product that attracts a user base unlike any other in size and activity. It is not uncommon nor surprising to see investors pay the type of premium relating to the P/E multiple that FB commands today, or at the IPO price for that matter. For those investors that have a higher risk tolerance and a longer term investment time-frame, FB will probably turn out to be a good investment. Just as easily as the worldwide media outlet, and every big portfolio manager on TV talking their own book, can breed only negative sentiment and disfavor towards a company, they can flip the script and begin to add "perceived value" to FB once again.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FB over the next 72 hours.