Is Facebook Worth the Trouble?
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After seeing its stock plummet after the IPO, Facebook (NASDAQ: FB) has come back and now trades around $28. Investing in this company may seem like a great way to play one of the most highly used consumer products in the world, but looks can be deceiving. Revenues are growing but costs are growing as well. At a current PE ratio of 279.8 Facebook is too expensive to be considered a good investment.
The famed investor Peter Lynch told people to "invest in what you know." It is easy to misinterpret his saying to mean that you should invest in whatever you use. Almost any American owns a car but that does not mean investing in car manufactures is always a good idea.
It is debatable if Facebook has a strong economic moat, but I believe that it does indeed. Starting a social network and getting hundreds of millions of individuals to join and visit consistently is not easy. Google+ has shown that a successful social network is not birthed overnight, and even billion dollar multinationals cannot simply press a button to achieve instant success.
This moat is not enough to save the company from its current valuations. Overall, revenue should continue to grow over the next couple years as Facebook's re-targeting platform becomes more popular and more of their ads are moved within the news feed. This positive trend is not the only factor impacting the firm. In the last quarter, daily average uniques in the US and Canada only increased from 130 million to 132 million. The growth in the number of daily users is stronger outside of North America. The value of this growing user base in developing nations is somewhat questionable. A consumer who makes $5,000 per year is worth much less in advertising dollars than a consumer who makes $30,000. As smartphones continue to penetrate developing nations the total number of impressions should continue to increase, but how much revenue will this bring in? Costs continue to increase and their EBIT margin of 12% is much less than Google's (NASDAQ: GOOG) EBIT margin of 28.1%.
Google is in a very different situation. Google operates a duopoly in the search engine market in a large number of countries. There are huge barriers to entry in the search market. Even as Microsoft has been successful in buffering Google, their online services division continues to bleed money. To run a successful global search engine, billions of dollars are needed for data centers, engineers, and a strong sales force. In addition to their search assets, their Google+ social network continues to grow.
Looking at the fundamentals, Google currently trades at a PE ratio of 21.8 and boasts five year revenue growth of 22% and five year EPS growth of 22%. The Internet backbone continues to grow and Google is in a great position with YouTube to benefit as consumers move from the consumption of static content to video content. Google offers growth and a very reasonable valuation given its moat in the search market and strong growth profile.
LinkedIn (NYSE: LNKD) is another player in the social networking sphere. It is focused on professionals and businesses instead of taking a more generalized approach. Like online job boards, LNKD helps to connect job seekers and businesses, and this strategy has allowed them to grow from $81.7 million in revenue in 4Q 2010 to $252 million in 3Q 2012. The company has a very slim EBIT margin of 4.6% and a return on assets of 1.4%. LNKD does not have the same moat as Google or Facebook. Monster, DHX, and search engines all compete in the online job space and keep it a very competitive market. With expected 2013 EPS of around $.46 and LNKD's current price of $114.35, it currently trades at a PE ratio of 248.6. LinkedIn has terrible margins, is in an competitive market, and already trades at a super high PE ratio. Until prices come back down to earth, the company is best ignored.
Social networks are still the flavor of the day, but that does not make them good investments. Facebook is used by a large percentage of the world's population, and this helps to give it a huge amount of PR. This PR can easily transfer over to Wall Street and cause investors to ignore stronger companies with more dependable growth prospects. Google is a better investment as it offers strong growth, a reasonable valuation, and a large economic moat.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook, Google, and LinkedIn and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook, Google, and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!