Friday, 27 July 2012

Facebook update, Q2 2012

Facebook's shares hit the stock market on the 18th May 2012 at $38 per share, and at the time I wrote that it was overvalued at that price. 

The shares did go on to perform badly and lose value, spending most of the time since May hovering around $27-$33, rather than in the $40s as many predicted. However, I didn't think it was worth another post to point this out and gloat about being right, for two reasons:

1) I didn't expect the shares to do so badly, so quickly. I thought the level of mass optimism was enough to keep them flying for months to come, so their actual performance was a pleasant surprise to me*.

2) The movements over short periods are largely random and unpredictable. It's stupid to try to predict them, or to claim credit for such predictions coming true. You might as well predict the rolls of dice.

I subscribe to Benjamin Graham's maxim that in the short term the stock market is a voting machine but in the long term it's a weighing machine. That is, market prices are always potentially subject to fashion, fads, and the whims of popular opinion which are unpredictable, but in the long term true value will out: the good will pull ahead and the bad will fade away.

So here's what I expected to happen: in the short term the price would continue to defy gravity, held aloft by mass delusion, but over time the drip-drip of successive quarterly results coming in below par would eventually become unbearable and reality would break through. Each disappointing set of results would be accompanied by a plausible-sounding excuse, but eventually even True Believers would begin to spot the pattern.

It's worth reiterating that "disappointing results" for Facebook aren't necessarily bad results, even very good results would be disappointing because the valuation is so high. The valuation requires them to consistently set the world alight with amazing results, especially if those original investors at $38 are ever to see any return on their investment. That's why I am sceptical that they ever will.

They released their Q2 results yesterday, so with actual new information to work with I thought I'd have another look. Overall, these are good results: 
  • revenue was strongly up both on the previous quarter and on the same quarter last year.
  • underlying profits were up. There was an overall loss based on what we are told were one-off costs from staff bonuses resulting from the listing (did I mention that each set of results would be accompanied by a plausible excuse for under performance?), but I accept the reason given and the underlying business performance does look good.
  • the number of active users grew strongly.
  • ignoring the exceptional costs, operating margin was 43% which is very good, though it's down from 53% a year ago. 
On the basis of these good results, the share price fell 9% on the day, from what were already low levels compared with May's listing price of $38. They now stand at less than $27. In a nutshell this is the problem that Facebook investors must confront: good results are not enough, expectation is off-the-scale high, so even if the company does well (which it has) people who bought at $38 may lose money (which they have).

Back in May I suggested that PepsiCo would be a better investment than Facebook, based on the arbitrary criterion that both Facebook and PepsiCo were valued at just over $1 billion. Since I expected Facebook to do badly, almost any successful company looked a better bet, so I picked PepsiCo just for grins. Back then PepsiCo's share price was $68, today it's $71.22 and they've also issued a $0.54 quarterly dividend, so buying PepsiCo at $68 you'd have been up by $3.76 or about 5.5%, compared with a 29% loss on Facebook. Slow and steady wins the race...

Disclaimer: I don't hold shares in either Facebook or PepsiCo and I'm not suggesting that anyone else should buy them either. It's just an interesting comparison between a hyped up newcomer and a solid old-timer. I generally I prefer to invest in solid old-timers rather than hyped newcomers, mainly because I invest to make money rather than to join in a party, but I'm a bit dull like that.

* Why am I pleased the price didn't "pop" up into the $40s as many hoped? Because I don't like seeing investors lose money. The higher the price, the greater the losses that will eventually be suffered by unsophisticated investors sucked into buying them on the back of media hype. The quicker the share price gets to a fair price based on sober analysis, the better.

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