Thursday, May 24, 2012

Should you Buy Facebook Shares?


Websites are investments. With a good web strategy and proper execution, you will have a decent return on investment. The stock market is another way to invest your savings.

When Google (Goog) entered the stock market in 2004 at $85/share, I thought the earnings growth predicted was ridiculous and stayed on the sideline. I was wrong. Google had a solid business model and was creating value for its customers. Now the price for Google shares is around $600 and the price / earnings (P/E) ratio is around 19.  I think the outlook is great and I recently bought a few shares.

Now that Facebook stock (FB) is available, what should I do? The stock was issued at $38 and is now trading at $31, after a few days, with a P/E around 70.

Finance 101

The price of a stock is based on the expected capacity to generate profits in the future. A P/E ratio of 14, about the average in the US stock market, means that for every $14 invested, you expect to receive $1, for a 7% return on investment. When a company has a P/E ratio is higher than 14, to obtain the basic 7% return on investment, the company’s net income must grow faster than the majority of other companies.

In an initial stock offering (IPO), the company executives have all the facts and they partner with Wall Street investment firms which provide the hype machine and the sales distribution channels. Together, these two entities try to maximize their personal profits.

Facebook price short-term outlook

People have not made much money on the stock market in the last 5 years and many are looking for a silver bullet to fix their pension funds. These people want to believe (like Mulder) and their hopes will be fanned by Wall Street spin doctors and con men.  Add to that the social media hype and you have a lot of people who have unreasonable expectations. I expect that the price of Facebook shares will fluctuate wildly for the next 18-24 months. Buying Facebook stock is not an investment decision, it is more akin to playing the lottery.

Facebook price medium-term outlook

Just like Google, Facebook makes money from ads and it probably has the best system to target ads based on demographics and interest. However, it is interruption-based advertising. Who wants that? Who clicks on that? Not that many and that may be why Google generates 10 times more revenue, mostly coming from its intent-based advertising on Google Search.

This is not to say that Facebook will not be profitable. According to financial reports, Facebook generated 4 billion dollars in the last year and 1 billion in net revenue. That is a lot of money. They will probably double or triple those numbers in the next 24 months. That is excellent but not good enough to justify their P/E ratio. Eventually, people will come to their senses – it happens – and they will realize that the growth in Facebook revenue will not meet their unreasonable expectations. And then the stock will take a plunge.

Can this be reversed?

The short answer: very unlikely!

For starters, this is a company that will not give the time of day to a business with 10,000 fans on its platform. This is a company without phone or email support for business pages. Furthermore, Facebook is managed by very smart guys with supersize bank accounts, supersize egos and very little management training.

Disclaimer

This post is the personal opinion of someone who had university level training in finance but never worked as a financiel analyst. Whether you buy or sell stock does not change my life. It only changes yours. Act accordingly.

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Update:

  • On 2012-08-09, the FB stock was trading below $22.
  • On 2012-09-01,  the FB stock was trading at $18. Goog was trading at $685.



1 comment:

shale watson said...
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