Free 7-day Trial
All Articles and Columns »

Facebook in the stock market... fashion or profitability?

Gabriel Canelli

Gabriel Canelli

9 followers
Like in any social activity, the stock market has its own cycles when it comes to fashion. In those cases, bulls buy in mass, without much debate or any logical reason. This leads to an overvaluation of the vast majority of companies that speculators prefer. It was not long ago since we suffer the phenomenon of "the dot-com bubble". In this instance there was a great speculation about the acquisition of shares in

Internet companies, which were overbought, causing price increases that were not related at all to the company’s value. Prices were so high and so different from their real value that inevitably caused a distortion in the market. That was what led to the great world crisis of 2001.

Today, although there is not a bubble declared, we can appreciate an overvaluation in some sectors of the economy. The PE is the basic step for valuing a company in the stock market, which compares the price with the EPS (the acronym for earnings per share). It should be accepted, a PE< 20. Nowadays, speculators seem to have a preference towards computer service companies. Examples as Linkedin (LNKD), whose price is USD 99, that equals 900 times the diluted earnings per share of USD 0.11 from last year. Also, Amazon (AMZN) has a price of USD 213.5, being 156 times its diluted earnings per share from last year of USD 1.37.

One of the subjects people keep talking about is Facebook (FB) launched on Friday May 18, 2012. Facebook belongs to the same sector as the companies that were mentioned before; and it is in a similar situation referring to its value. The initial price was 38 cents per share, 88 times the EPS of 0.43. As an investor I would look for stocks that traded lower or equal of its intrinsic value so as to leverage its growth and then obtain an appropriate return. When Facebook appeared on the stock market, it had a PER of 88. Since that moment, we can see signs of an overvaluation, and if we take it a little further, revenues were $ 3.711 billion and its operating profit was $ 1.549 billion in 2011, contrasting with the initial capitalization of 88.616 billion dollars. I would not recommend the purchase of shares in a company that the sales are 24 times the price paid by the company, or 57 times operating profit, no matter how promising the prospects are.

I have read recently an analysis that claims that if Facebook keeps the rate of earnings growth from the year 2010 to 2011, the company has a proper value. The truth is that nobody can know what the future holds, and the rate of earnings growth which is referred to is around 65%. Conventionally, there is no

history of any company that has grown at this rate more than a few years, and, of course, the most possible thing to happen is not reaching to offset the price paid. Even if we are talking about a company that is now having a very good performance, the price is excessive.

Every business has cycles over their activity; Facebook is in the first stage of growth. This kind of companies grow at high rates for some years but then, when mature, this rate will be reduced to normal levels and will remain at about 8 or 10% (ex.: Coca Cola).

Paradoxically, nowadays we can find companies that had once attracted the attention of speculators and are now lagging at very reasonable prices. Although it sounds strange, let’s talk about Microsoft (MSFT), the giant corporation with an exceptional performance, revenues of USD 69.943 billion, net income of USD

23.150 billion and is trading below its fair value. This company has a ROE (return on equity) of 44%, profit growth of 10% and annual revenues growth of 7% in the average of the last 10 years. We

can appreciate that Microsoft indeed is situated at a later stage of the cycle than Facebook. It

is reasonable to think that in future years this growth will be maintained. If we compare with the average competition (Apple, Oracle, Google, Sony) Microsoft is in a privileged position. The average ROE competitors is 28%, gross margin (percentage of gross sales) from Microsoft is 78% and for the average competition 53%.

Concerning financial strength, Microsoft does not have a short-term debt and a long-term debt is fewer than its current assets, this gives us the confidence that is necessary to cope with any crisis.

From the point of view of its valuation, Microsoft's PE is 10.78 in a price of $ 29, earnings from operation activities are 26.994 billion and its market capitalization is 249.197 billion, which is 9.23 times the total capitalization. On having compared these numbers with Facebook we see the overvaluation of this, and how the popularity or fashion of certain companies can lead to overvalue, generating big risks to the carriers. At present Facebook quotes 31.54 with a PER of 73, meaning that after falling 17 %, is still overvalued. Being overvalued does not mean going to fall down at once or going to suffer a crisis, probably in the short term could fluctuate in these prices, but in the long term or in a period of crisis, these are the companies that suffer the most.

To conclude and finally get the stock market’s irony, on the financial crisis of 2008-2009 Microsoft was able to quote on the lowest point of USD 15.28 with an EPS of 1.62, forming a PE of 9.43, and at present we have a PE of 10.78, a mere 14% above the lowest point of the crisis of 2008.

About the author:

Gabriel Canelli
I am from Uruguay and I am 24 years old, with an almost finished grade in the area of Economy. Since 2009, I specialize in value investing.

Rating: 4.6/5 (35 votes)

Comments

Zavala
Zavala - 1 year ago
Excellent analysis of an issue these days is making headlines around the world.

Vero1377
Vero1377 - 1 year ago
very interesting report!

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Hide