With Facebook (FB) due to release earnings this week, investor excitement has begun to die down. The IPO, widely regarded as a flop, has been followed by increasing anxiety over future growth. ~$20B of value has been erased in just a little over 2 months since the social networking giant first went public. Shares started to recover early-June, plateaued in mid-June to mid-July, and have started to fall towards the 52-week low of $25.52 per share.
Investors certainly have much to be concerned about. At 91.8x PE and 43.8x forward PE multiples, considerable growth would be needed to justify the current valuation. How much growth? Well, over the trailing twelve months, the company yielded EPS of $0.31. Analysts expect 2013 EPS to be more than double that amount at $0.65 and then to grow 26.9% in the near-term. Consider that EBIT in 1Q12 was $381M but $388M in 1Q11. Assuming that the company grows EPS annually by 40% (beating analyst high double-digit expectations by more than 1,300 basis points each year), 2016 EPS will come out to $1.78. At a 15x multiple, the company would be worth $26.75 in 2016. Discounting backwards by a generous 10% rate would justify a $16.61 present valuation.
Put differently, even if Facebook grew EPS annually by 40% following the Street's expectation for a doubling in 2013, the company would still be substantially overvalued. This bullish forecast is even, again, 1,300 bps more optimistic than analyst expectations - and on annual basis. Hence, even the power of compounding can't justify growth.
One way of looking at Facebook is to consider Google (GOOG). When Google first went public, many commentators argued that the search engine business was inherently unstable and there was no way for the Wall Street darling to continue momentum and diversification. More than 7 years later and Google has nearly sextupled in value and become a leader in mobile, expanded into email, opened up a variety of complementary applications, and is a force so powerful that it has the cash that justifies exploring virtual glasses and driverless cars. Who would guess?
How much growth did it take for Google to get where it is? The search engine giant had nearly $400M in earnings when it first went public, or $2.07 per share. In 2011, it had $9.7B in earnings, or $36.04 per share. But Google had showcased - and, in my view, continues to showcase - that it is on a better part of the growth curve than Facebook.
Going forward, I am unsure about Facebook - certainly more unsure than what I feel about Google. Social networking looks faddish and the stuff competition is made of - there is nothing stopping Google+ from catching on like wildfire. Investors have myopically forgotten that MySpace actually predated Facebook and only went "extinct" when users found the next "hot thing". Facebook's growth was thus predicated upon faddish, speculative trends. Acquisitions from Instagram and Face.com have been almost permissively excused by shareholders, especially when considered in the context of the founder's controlling power.
Facebook's path forward is to diversify away from social networking and build a stabler foundation. In the meanwhile, I recommend buying shares of Google, which has synergistic value across several channels: search, mobile, and social networking.
For right now, Facebook shareholders have one thing to be happy about: it is not the most overvalued hot stock on the Street. That honor goes to Amazon (AMZN). The eCommerce company trades at a respective 182.8x and 86.1x past and forward multiples - both higher than Facebook's. Even though 32.3% annual EPS growth is expected over the next 5 years (again, higher than what is expected for Facebook), the company still has a PEG ratio of 5.7. A PEG ratio of 1, which Google trades at, indicates that future growth has been fairly factored into the stock. Facebook has a PEG ratio of 3.4 on analyst expectations, which leaves Amazon in, well, the Amazon.
I am not quite sure where the capital markets think a nearly-20-year-old firm is suddenly going to each this kind of explosive growth from, but it's enough to say that the company is overvalued. Amazon grew a staggering 25% annually in EPS over the past 5 years, but growth doesn't simply accelerate more than 700 bps out of nowhere for nowhere reason. Kindle Fire is a tough sell for value creation given tablet competition and low profit margins. Greater consumer expenditures is equally tough… most economists are lamenting the sluggish macro growth. Business transformation? Amazon has potential on the cloud, but I would give that reign to Oracle and software producers less focused on the business-to-consumer level (ORCL).
Even if Amazon grew EPS by 50% annually over the next five years (nearly 2,000 bps higher than analyst expectations each year), the stock would be worth $131.12 five years from now at a 15x multiple. Discounting backwards generously by 10% yields a present value of $81.42. Thus, even when I apply extremely optimistic forecasts about the company, I still find the company to be overvalued by more than $63B. It's hard to say how low shareholder value will go if I were to apply realistic numbers…
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.