Friday, 18 May 2012

Facebook is overvalued

You may have heard in the news that Facebook gained a stock market listing today, trading at around $38 per share. That values the company at $104 billion which is 88 times its annual earnings, or an earnings yield of about 1.1%. 

Oh, hold on, my phone's ringing.

That was the 90s on the phone, they want their insane tech stock valuations back. Actually, that's not fair: Facebook is at least profitable and cash generative, so we are spared idiotic analysis about rates of cash burn.

Personally, I am inclined to value Facebook at between $6.30 and $8.60 per share. That would value the company at 15 to 20 times its earnings or an earnings yield of 5% to 6.7%. If you feel really optimistic, maybe go to $10 which would be just over 23 times its earnings or 4.3% earnings yield. But $38 is just batshit insane, it's hard to see how anyone buying at that price will make money, other than by selling it to someone even more stupid (the Greater Fool Theory of investment).

Many would call my valuations over-cautious, especially all those people today who've paid 5 times my suggested price to buy Facebook shares. They will argue that Facebook is growing rapidly, will continue to grow rapidly, its future profits will be immense and I am an idiot to pass up such an opportunity. Perhaps that's true.

I would argue that Facebook's profits must grow about 500% even to justify today's price, and once they've grown by that amount those profits would still need to show strong signs of future growth if you expect to make any money as a shareholder. There is a vast reservoir of optimism baked into that $104 billion price. Even if the company does grow, its shareholders could lose money if the growth isn't rapid enough. As the economy recovers I'd expect advertising revenue to pick up, even so Facebook is a long way from demonstrating that it can actually generate $5 or $6 billion in profits; currently it's earning about $1.1 billion from revenues of $4 billion. Assuming it maintains its 24% profit margin, its revenues need to reach about $25 billion to justify today's price, and would need to look like continuing to grow from there. Maybe they will, maybe they won't.

There is also the risk that 2, 4 or 10 years from now people are just kinda bored with Facebook and go somewhere else. Ten years is a long time away: no one can predict online social trends so far into the future, but Facebook's price says they can predict at least that far. 

As it happens, the snack and beverage group Pepsico is valued at about the same price as Facebook: $106 billion on today's share price of $68. Last year they had $67 billion in revenue and earned $6 billion in net profits. Which company looks like the stronger bet? What are the odds that people are still drinking Pepsi, 7up, Tropicana, Mountain Dew or Lipton, while eating Walkers, Doritos or Lay's, or Quaker oats 10 years from now, versus the odds that Facebook is still going and has revues and profits 10x today's?

Just for fun, I'll track the revenue, profits and valuation of Pepsico and Facebook to see how things pan out. Feel free to bookmark this post so you can pop back periodically to laugh in my face, comments will remain open :)

All financial data from Yahoo! finance, correct as far as I'm aware. I've not personally taken a financial position in either Pepsico or Facebook.


  1. Ok,I'll argue. Other earning-to valuations:

    We have never, in human history, had a product like facebook. I personally feel it is grossly undervalued at $38. They have *900* million users, and ZERO market share in China. It is an immature product (2-3 years old), and it has only started to scratch the surface in terms of A) monetizing the user base and B) leverage 1.8 Billion eyeballs.


  2. Hey, congratulations on being my first ever commenter!

    On facebook: even if it changes the world, and to some extent it already has, that's no guarantee that shareholders will do well buying at the current price.

    Consider aviation. That has transformed the world far more than Facebook, but investors in airlines have tended to get reamed. Airlines are run mostly for the benefit of senior pilots. Senior executives do OK too, and customers are a lot better off than when the only option was a ship. But shareholders, not so much.

    I don't say that today's Facebook buyers will definitely lose, but it's a high risk gamble requiring confident predictions about unknowable things. But that's why I'll keep tracking it, because there's no point making a public prediction unless you're willing to repeatedly look like a doofus when it blows up in your face!