Facebook is awesome. With nearly a billion users, it’s the world’s most popular web site and thanks to that popularity, it’s the largest IPO in US History raising more than $18 billion in cash (the amount raised is actually #2 to Visa) at a valuation of $104 billion (Ticker: FB). But the popularity of the stock has pushed its valuation even further on the open market where all billion Facebook users can now own a piece of the action.
As of this writing Facebook is worth over $110 billion and it might keep going up further. But is the valuation justified?
To answer that question, we have to do some comparison shopping. Specifically, let’s compare Facebook to some of the other tech titans:
Facebook has managed to get a valuation that’s about half that of Google with just one tenth the sales and profits. With a Price/Earnings ratio of more than 100, Facebook has to continue to grow revenues and profits at astronomical rates for 4 or 5 more years in order to justify its stock price today.
What Does PE Mean Anyway?
The Price/Earnings ratio of a stock tells you how many years it would take, at present profit levels, for the company to be able to generate enough profits to buy the entire company at its current price. For Facebook, that number is 104 years! For Apple, it’s just 13 years. So if you bought all of Facebook today for $104 Billion, and its profitability remained the same, you’d get your money back by the year 2116. That’s a smokin deal, right?
So why is Facebook so overpriced?
The reason, of course, is because the stock market works off of supply and demand rules. Right now, there is an enormous amount of demand for Facebook stock because every investor in the world is also a Facebook user. However, most Facebook stockholders have restricted stock which can not be sold on the open market…yet. That makes the supply side of the equation out of balance. At least for the time being.
Eventually though, usually about 90 days after the IPO, the restrictions start to lift and that’s when the supply side of the equation starts to increase. With more supply, the eventual price of Facebook stock will be much more inline with market standards for a growth company. That number is usually around a PE ratio of 40.
So should you buy or sell Facebook? The answer is, nobody can tell you for sure. Supply and demand rules for stocks are largely unpredictable. However, business rules dictate that Facebook needs to be making A LOT more money to justify its current stock price.
[Update: I was asked if I’m personally long or short on Facebook. The answer is that I don’t hold any Facebook shares at the time of writing this article.]