Seldom is the difference between a "value play" and "hyped play" more obvious than it is between Google (GOOG) and Facebook (FB). One runs a media business that has successfully diversified and where the existing advertising method works. Another runs an unproven business model where the existing advertising method has already shown weaknesses. Whereas Google provides a meaningful answer to human needs (ie. coherent access to information), Facebook tries to create its own demand (ie. few "wanted" a social network before it was offered).
Put more simply, Google has sustainable growth ahead while Facebook is more of a fad. And like all fads, Facebook has turned into a bubble of monstrous proportions - one that is even dwarfing those seen during the dot-com era.
Facebook currently trades at 101.6x past earnings and 48.8x forward earnings. To put that into perspective, consider that the stock market had a Shiller PE multiple of around 44x at the height of the dot-com era -- a level not seen when dating back to as far as records go (the 1880s). For Facebook to be worth more than that multiple on a forward basis requires a bit of hype, to say the least.
It is true that with 800M users under its control, Facebook runs its own virtual economy. In my belief, the company should explore strategies outside of pay-per-click advertising, since social networking users (as opposed to search engines users) don't solicit the promotional clutter. Advertising through banners and random paid-for links feel more intrusive than anything else. A better strategy would be to work with companies like Zynga (ZNGA) that actually introduce a third-party platform to improve the existing social networking experience. There are ways Facebook could still "work," or be relevant, five years from now. Here's hoping that it succeeds.
As it stands, however, Facebook remains a fad. Just like instant messaging and MySpace (which, mind you, predated Facebook) went the way of the Dodo, Facebook may very well be in the same position. Assuming that the company more than doubles EPS next year off of the 12 trailing months and grows 26.8% annually thereafter, 2020 EPS will come out to $3.42. At a 15x multiple, the future stock value comes out $51.38. However, 26.8% earnings growth is highly uncertain, especially in the context of deceleration and disappointing recent performance. In fact, the company yielded $233M worth of net income in 1Q11 and only $205M in 1Q12. Moreover, 7 years is a long time, and the fad could end by then. Accordingly, a 12% discount rate is reasonable for this rising social media business. Discounting backwards by 12% puts the price target at $16.54. Facebook should be worth half of what it currently is.
I encouraged investors to consider shorting Facebook in the long-term but to be weary about the beginning hype. My bearish stance has thus far been true given that the stock has fallen by 16.5% since the IPO. At the same time, bears who opened a short position at the low would have suffered from the stock swinging 25% in the up direction. Yes, those same bears would have been shorting a stock that, in my view, is so clearly overvalued but market momentum simply was not heading in that direction. The American economy, thankfully, is built of optimism.
Instead of shorting Facebook stock, investors should back Google and remain neutral on Yahoo (YHOO). While Google still has a strong brand and excellent fundamentals, it nevertheless has lost much of its lost luster as giants like Facebook and Apple (AAPL) emerged on the scene. By contrast, Yahoo has failed to develop its fundamentals as the overall tech scene dramatically outpaced in innovation.
Moreover, at a PE multiple of 18 and a forward PE multiple of 14, Yahoo it is at an odd 5% - 25% premium to Google's value, so it lacks a value gap. Yahoo currently is rated a "hold" on the Street versus a "buy" for Google according to data from FINVIZ.com. Google is also much more cash liquid than Yahoo, as the former has a current ratio of 5.8 and 26.5% of its equity value in cash. Greater liquidity will enable Google to acquire more additional businesses of synergistic value than Yahoo. In the process, Google will continue to outperform its lagging peer.
Google showed a knack for out-innovating Yahoo that many market commentators failed to note as it occurred - it sort of "just happened". One thing that has not received enough attention today is how Google is doing the exact same thing with Facebook …
I am talking about Google+, which has grown in users and fundamentally provides the exact same thing as Facebook but only better integration on search engine results. Note how founders Sergey Brin and Larry Page, however, are not making a big deal about it. Brin himself said that he doesn't "get" the sensibility, or enjoyment, in posting random comments about one's "status" every few minutes. He's right and, in the process, showing how faddish how Facebook currently is.
By reducing Google+ to a mere tab on the far left of the Google dashboard, Brin and Page are suggesting that social networking should be viewed as an auxiliary appendage of something more helpful in life: search results. The company has actually integrated social networking content into its search results, which is the logical extension of where Facebook should go if it could. That is to say, Google can do everything that Facebook can and more, but Facebook cannot do everything that Google can.
The tech industry will be shaken when Facebook's bubble bursts; but, when the dust settles, one giant will be soaring: Google. Hedge now.