Will Facebook's Earnings Catch Up To Its Valuation?

| About: Facebook (FB)
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Facebook (NASDAQ:FB) a relatively new company to the stock market has traveled a rocky road in a short period of time. Its shares were listed at $38 and shortly thereafter plunged to a year low of $18.80; just as quickly the shares rebounded and have recently hit a yearly high of $51.60, the shares have pulled back slightly, and are now trading at just over $49 per share.

At this price it is trading at a P/E of 204 with a market cap of $113 Billion. Wall Street sure has priced a lot of growth into the stock. According to Reuters the PE for the industry is 28.39. Facebook would have to increase its earnings by almost 700% to bring its earning in line with the average PE for its sector.

It is slightly disingenuous to compare Facebook to its peers because in some respects it doesn't really have any, at least if you're looking to stock market listings. It is commonly mentioned along with the other large tech titans: Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), and Microsoft (NASDAQ:MSFT), but these are very different companies. The closest competitors in social networks are: Twitter, Instagram (owned by Facebook), and Google+. All of these social networks have been posting strong growth numbers, although Google+ has become tied into so many of Google's services that the numbers are not completely accurate - you may never use Google+ but by logging into a Gmail account you will also be using Google+, so its numbers are inflated.


Facebook has shown strong growth in both revenue and gross income with the figures as follows:












Gross Income






The net income has not been as impressive during this period, partly due to large re-investment during a growth phase, quarter two of this year has shown an improvement in net income with YTD of $552 million, and revenue growth continues with YTD revenue of $3.27 billion.

The biggest recent challenge for Facebook's growth story has been the shift to mobile, so far it appears to be up to the challenge; in its second quarter results its MAU (monthly active users) for mobile were 819 million, an increase of 51% year over year and close to MAUs of 1.15 billion on other devices. It has continued to drive advertisers to its platform, recently surpassing 1 million active advertisers with a lot of this growth coming from local businesses.


Stickiness defines how much people use a site and continue to return again and again. Facebook certainly succeeds in this area and by adding more and more functionality, for many people, it has become a vital service. This fascinating article shows how some users are running their entire social lives through Facebook and it is, potentially, as vital a service as any utility.


The majority of Facebook's revenue comes from advertising, this continues to increase quarter over quarter but there is a problem here; Google has a similar model of driving its revenue from advertising but it has a completely different user engagement -- the user is an active participant in searching for information and therefore advertisers receive a higher click-through. Facebook's advertising is more intrusive, and therefore, the user is not as engaged in advertising content resulting in a lower click through. Meaning Facebook is unlikely to achieve Google-like revenues with advertising alone. This is not an immediate concern. Facebook can continue to increase advertising revenues for many quarters to come, but it will need to look for additional revenue opportunities that take advantage of its huge user base and depository of user data.

The alternative, something Facebook is trying, is to alter the way users interact with Facebook. It has recently added a feature called Graph Search which allows users to perform similar queries that they would perform in Google Search. It also allows them to perform queries that Google is unable to do such as "which hotel did my friends stay at in Mexico"?

These kinds of queries would have a lot more user engagement resulting in Google-like click-through, and it could take a slice of several different industries such as dating, job search and property listings, just for starters. Facebook hasn't broken out any more details on the success of this feature so for the moment it is only an area with a lot of potential.


Facebook is in a unique position with a massive user base and an equally large and growing store of personal data; it is still looking for alternative ways to exploit this position, and has been showing strong growth quarter after quarter. Unfortunately at the current price it has a lot of growth already priced in to the stock and it will have to show some strong growth just for its earnings to live up to its current valuation. There is potential for further appreciation in the share price but due to the high valuation this also comes with considerable risk and I would not recommend buying at the current price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.