Seeking Alpha
Long only, value
Profile| Send Message|
( followers)  

Back in April, before the IPO and the bust and the subsequent angst and anger, a friend of mine asked me to look into Facebook (FB) as an investment. Her 13-year old daughter (not yet a member of Facebook, mind you) wanted mom to get involved in a company she knew about and cared about.

About a year prior (March 2011, to be exact), I finally took the time to sit down with some money I had and begin investing in the stock market. I pored over a list of 5-star stocks as ranked by S&P Capital IQ and noticed Apple. I knew Apple (AAPL) was about to announce the IPad 2. I thought there might be a pop, and so made my first stock purchase.

I relate these two anecdotes not because I think you care (I should rather think you don't), but because they illustrate a point about investing in stocks such as Facebook and Apple. The stocks are not solely mega-cap stocks (though Facebook perhaps doesn't qualify) but also mega-interest stocks. The most on hand data to see this is Seeking Alpha's numbers: Facebook has 7,318 real time alert subscribers (as of July 29th) and has had 270 focus articles written about it since May 1st. Apple has 49,614 RTA subscribers and "only" 267 focus articles to its ticker since May 1st. For comparison, General Electric (GE) has 16,344 RTA subscribers and has had a mere 55 focus articles written about it. Facebook's proportion is spiked no doubt due to the initial interest in the company, the heavy amount of news and speculation over the company's controversial start to public life, and the general "newness" of the stock, but there is no sign that this interest will slow materially over the coming months.

The challenge to investors is that all this interest about a stock leads to an abundance of information on the stock, counteracted by an equal or greater abundance of misinformation. Further, since most institutional investors - fund managers and their ilk - are not eager to miss out on a good thing, funds load up on these mega-interest stocks or dump them in waves and herds, making it difficult for individuals to gain the edge. Individual investors are all the same likely to buy into companies they know, companies they think are doing well, like Facebook and Apple.

But if alpha is "excess return" compared to the market, it's hard to use these stocks as ways to generate alpha when everybody in the market is invested. Instead of finding edges and incomplete information to take advantage of and soar, a more sophisticated investor is forced to play weatherman, guessing which way the wind blows before deciding whether the investment is worth making or not.

Lord knows you don't have to be a weatherman to know which way the wind blows, and you don't need to possess an edge to profit on the market's wishes or its worries, its joys or its jeers. It's just that the abundance of information and misinformation becomes a liability when dealing with stocks like these, one that the investor has to work through.

***

It's ironic, given that Facebook's M.O. is encouraging people to share the most personal and inane details of their lives online where the world can see it, that Facebook got dinged after earnings in large part for not providing enough concrete information about the company's prospects. In fact, for all I said about the interest and information in and about the stock, the future is still somewhat fuzzy and left to conjecture.

The numbers on Facebook's call met expectations. Lowered expectations, perhaps, but Facebook did clear the expected hurdle, with revenue of $1.18B and operating EPS of $.12. Comments from COO Sheryl Sandberg and CEO Mark Zuckerberg mostly focused on the social ads initiatives that Facebook is growing or promoting. While this can read on the page like the latest step in the inevitable, sinister turn of our lives into an advertising runway ala a George Sanders fantasy, management insisted in the Q&A portion of the call that they were adding sponsored stories into the newsfeed slowly to not spook users, a measured pace that could serve both users and investors well as the increased effectiveness seeps into the top and bottom lines.

More alarming to investors was that no specific guidance was given. Without a track record of past earnings calls to rely on, there was no predicting management behavior on this count, but the lack of either an outlook for the rest of the year or for the upcoming quarter was a sign of too little information. The piece of information about the future that did slip out, in CFO David Ebersman's portion of the call, was that operating expenses (excluding stock compensation) would increase significantly in the second half of 2012 compared to year prior, or at a rate slightly higher than Q2's 60% year over year increase in expenses. "While we ultimately believe Facebook's business model should support attractive operating margins, at this early stage of our growth, investment is a top priority as opposed to managing for a target margin," stated Ebersman.

In light of the forecast for increased expenses, and with Ebersman citing several times in Q&A how difficult it is to predict revenue growth, enough alarm bells sounded to cause the nearly 12% sell-off on Friday (a sell-off that dropped as much as 17%). This sell-off has driven Facebook to currently trade 38% below its IPO price of 38/share and 47.32% below its post-IPO high of 45/share.

Facebook is not the first stock to sell off this drastically after an IPO, even if Facebook's IPO was the largest-ever and among the most criticized in recent times. I wrote a week ago about the idea of a "post-hype sleeper", a company that had an IPO recently trading near 52-week lows. Facebook isn't a sleeper, of course, but despite all the headwinds, the company has been profitable, is forecast to have earnings growth, and just breached its 52-week low Friday, all positive criteria for catching a turnaround.

Does this sell-off create a buying opportunity? On an absolute valuation basis, no: Facebook still trades at 29x 2014 earnings and a PEG ratio of 2.14. In comparing Facebook with social network peer LinkedIn (LNKD), online advertising giant Google (GOOG), and big-spending online powerhouse Amazon.com (AMZN), there are some notes of interest, however.

(Sources: WSJ, TDAmeritrade, Amazon's Q2 2012 earnings report)

As of most recent quarter

FB

LNKD

GOOG

AMZN

Market Cap

$50.7B

$10.7B

$207.7B

$106.9B

Revenue TTM (in millions)

$4,327

$616.71

$43,020

$54,326

Revenue/share TTM

2.3

5.54

108.36

118.62

Quarterly Revenue Growth (Q-over-Q)

11.91%

12.35%

14.38%

-2.66%

Quarterly Revenue Growth (Y-over-Y)

32.29%

100.63%

34.48%

29.47%

Yearly Revenue Growth (1 year prior)

87.99%

114.80%

30.03%

40.56%

Gross Margin (most recent quarter)

69%

78.77%

58.68%

26.07%

Gross Margin Growth, Q-over-Q (in BPs)

-482

139

-560

27

Gross Margin Growth, Y-over-Y (in BPs)

-754

532

-616

198

EPS Growth (Annual past two years)

104.00%

105.88%

24.67%

-10.61%

Estimated Earnings Growth (next 3 years)

25.79%

79.43%

17.26%

71.80%

Earnings 2011

0.43

0.35

36.04

1.37

Earnings 2012 (Est.)

0.49

0.68

42.58

1.06

Earnings 2013 (Est.)

0.64

1.25

49.45

2.67

Free Cash Flow TTM

NA

0.73

32.74

2.4

2011 P/E

55.14

295.49

17.62

173.23

2012 P/E

48.39

152.09

14.91

223.89

2013 P/E

37.05

82.74

12.84

88.88

TTM P/FCF

NA

141.67

19.39

98.88

P/S for TTM

10.31

18.67

5.86

2.00

PEG Ratio (for 2011 P/E)

2.14

3.72

1.02

2.41

Price (as of 07/27 close)

23.71

103.42

634.96

237.32

(Note: LinkedIn data is as of Q1 2012, and past EPS growth for LinkedIn is for only one year)

Facebook floats in something of a no man's land, and deservedly so. The company's shares still trade at multiples 3 or 4x greater than Google despite quarterly revenue growth and estimated earnings growth numbers that are comparable to or not significantly greater than Google's. LinkedIn's shares are much more expensive, but the company is growing earnings and revenues much faster and is freeing itself from dependence on advertising, a revenue source that may not be enough on its own to power a company of Facebook's size.

There are signs of hope in these numbers and Facebook's story in general. The sponsored stories part of the conference call suggests that Facebook is starting to take advantage of the opportunity (and challenge) that mobile advertising represents - though Zuckerberg dismissed the idea of a Facebook phone on the conference call, which appears to be a wise decision. Amazon's numbers represent the bull case for Facebook, not so much as a direct comparison (I do not want to imply that Facebook should trade at 89x 2013 earnings, for example) as a sign of what can happen to a stock's multiples when the interest and information turns market sentiment positive on a stock.

***

Any investment at this point in Facebook, whether short or long, would ultimately be a bet on one of two things: in the short-term, a bet on that sentiment and investor tide turning positive (or staying negative) for Facebook, and in the long-term, on Facebook figuring out (or never solving) the user monetization puzzle. Even as the numbers get more attractive - especially if Facebook does breach the teens as many predict - the short-term picture, with too many unknowns from Facebook's operations and too much conjecture from everybody else, shrouds the long-term. Picking up Facebook shares is like catching a wave, only with the current prone to change at a minute's notice and millions of seagulls squawking in one's ear, each telling you to buy or sell fifteen different ways.

Facebook has built an empire based on information. Eventually, I do believe that empire will become a very profitable one and one worth investing in. With the shortage of clear near-term information about how the stock is going to do, and with the surplus of unpredictable sentiment that is currently flowing against the stock, the right entry price hasn't come yet. Too many waves, too many opinions, and too many gusts to sort through and point one's weather vane: for now, I'll be watching the parking (and ad) meters and waiting.

Source: TMII: The Problem Of Too Much (And Too Little) Information And Interest Pt. 1: Facebook