Monday, 30 July 2012

Facebook Valuation

Facebook went public on 18 May 2012 at a price of USD 38 per share, valuing the company's equity at around USD 81.247 billion. Following poor results for Q2 2012 reported last week, the shares sold at around USD 24 as of market close on 27 July 2012. The share price has hence dropped around 37% since going public.

Does this mean Facebook could now be a good buy for an investor? Absolutely not. Based on 2011 financials, the shares currently sell at a Price-Sales (P/S) ratio of 13.83, a Price-Earnings (P/E) ratio of 76.82 and a Price-Book (P/B) ratio of 3.86 (based on Q2-2012 balance sheet). Based on trailing four quarters earnings, the P/E ratio is currently about 127. Assuming for example a fair P/E ratio of 18.8 (current ratio for Google), Facebook's earnings need to grow to USD 2,729.48 million to justify the current market capitalisation. This means that earnings need to more than quadruple from the USD 668 million reported in 2011 (which is the best year so far for Facebook) to justify the current market price.

Conclusion: the current market price of Facebook, even after falling almost 37% since going public, is still very expensive and is not a suitable investment for the prudent investor. The optimistic market price could have been easier to justify if the company had delivered tremendous growth in earnings and Return on Equity (ROE). That has not been the case so far in 2012 and this fact should not been taken lightly. The Facebook share price could very well turn out to increase significantly in the years ahead, but this would be wholly dependent on the company delivering huge increases in growth and earnings. But buying at the current level would be speculation. If you do buy it, do not be disappointed if it drops another 37% or more.


Disclaimer: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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