Facebook Defies the Law of EPS

Undoubtedly, Facebook stock is a topic that intrigues me – not because I’ve finally found the right moment to “cash in” on a little piece of social networking heaven, but because the stock price has been (and remains) a complete enigma. In my last post, Owning a Piece of the Largest Social Network, I argued against purchasing Facebook stock during its May IPO – primarily because the valuation (especially for a company with no sustainable business model and/or revenue stream) was insane. Fast forward five months later, Facebook stock has dropped 40% since its opening price of $38 a share and presently hovers around the high teens to low twenties – for many, this begs the question: “Is it finally time to purchase a few Facebook shares?” Well my friends…sadly…the answer is a simple “no” – at least in my opinion. Facebook stock continues to trade at ungodly multiples of their EPS (earnings per share) and its only a matter of time until the market adjusts – sending Facebook stock price plummeting to the low to mid teens.

Let’s break this down a bit. Earnings Per Share is the portion of a company’s profit that’s allocated to individual shares of outstanding, common stock – EPS is important because it gives investors insight into the overall profitability and health of the company. Recently, Facebook has traded as high as 47 times their projected 2012 profit of 48 cents a share (or, alternatively, 36 times estimated 2013 earnings of $.63/share.) Sound a bit high? Well, it is. To put this in perspective, let’s compare Facebook with two other giant, established technology companies: Google and Apple. With Google stock price at a whopping $757 a share and Apple trailing close behind @ $676, both companies trade around 16x of estimated 2012 earnings. Case in point – if Facebook is valued at $61 billion, that’s more than 10x their estimated 2012 revenue of $5 billion…Google trades at half this valuation. Don’t ask me why, because I don’t have an answer.

What makes Facebook stock valuation more puzzling is that it almost seems to ignore the flood of restricted stock the company has issued into the market (I’m assuming to prevent Facebook employees from debunking to Google/Apple/Amazon.) Again, let’s crunch some numbers: Facebook issued $1.4 billion of restricted stock in 2011 (or almost $500K per employee) while dishing out another $1 billion of restricted stock thus far in 2012. If the stock expense is amortized in the following years at, say, $.20/share that still leaves the company with an estimated $.43 ($.63 (-) $.20) EPS for 2013 that will have the company trading at 35x EPS if the stock falls to the mid teens in the future – this is still a high valuation. This high valuation also fails to ignore the continued dilution of Facebook stock as more shares move from restricted to unrestricted status.

Facebook has the ability to generate a great deal of revenue, but whether or not the company is able to develop a sustainable strategy to turn potential into reality is another question – I’m talking about Mobile. Facebook now gets, on average, $5 in revenue annually from each user – multiple this by a 955 million user base and that’s a good chunk of change. However, Facebook is far from solidifying a Mobile strategy that’s capable of driving large revenue streams – a notion that became apparent when the company shelled out $1 billion for Instagram (Facebook was apparently having trouble with the whole uploading mobile pics, thing.) Facebook needs to develop a mobile strategy, and fast – and by mobile strategy I don’t mean blasting users with Shared Stories every time they open the app on their smartphone. As more and more users move from checking Facebook on their PCs to Mobile, the importance of a Mobile strategy will only grow. It’s clear that Mobile is a “must” for Facebook, but it also acts somewhat as a double edged sword for the company – as more and more users switch to jumping on their iPad/iPhone/Android to update their status’ and check their walls, isn’t Facebook just giving Google and Apple a piece of the revenue pie? Think competition…

Second quarter revenue for Facebook had risen 32%, but expenses (including stock based compensation) rose 60% – I expect to see more of the same fluctuations if the company continues to flood the market with common stock and fails to put a dent in their Mobile strategy. Don’t get me wrong – I’m not saying that Facebook is incapable of generating revenue long term; however, for a company without a solid strategy… do I think the stock trading at twice the valuation of Google is a little, uh, odd? Yea, yea I do.

My advice – buy Facebook when the price falls to the mid teens.

 

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Dustin Lewis About the author
Comments:
  • Lisa Sanner
    Reply

    Good financial analysis Dustin! I’ll wait. 🙂

    September 27, 2012 at 4:06 pm

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