When Paying $100 for $1 of Earnings is Justifiable
Edgar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Facebook (NASDAQ: FB) has been suffering from a high P/E ratio syndrome ever since its IPO release in May. Most investors are complaining about its triple digit multiple, mulling the idea that $1 billion in net income that the company raked in 2011 is just not enough to maintain its current price levels. Here are four reasons why I disagree.
1. Price-to-Earnings Ratios Fall Short: P/E ratios don’t take into consideration the company’s debt nor growth expectations. There are several dangers associated with basing a company’s financial viability just based on theoretical multiples. And I use the word theoretical since the numerator constantly changes due to price fluctuations, and the denominator can be skewed and misguided by manipulating depreciation as well as non-recurring expenses.
2. $100 billion valuation is a bit exaggerated, $25 billion is fair: Pay attention to the Enterprise Value / EBITDA of 18.27, which is a more accurate valuation measure rather than the current PEG ratio of 2.76. Investors are quick to assume that a PEG ratio below 1.00 means they’re buying growth at a discount. This is not always the case. In 2010, Rackspace (NYSE: RAX) was trading with a P/E multiple of 210 and a PEG ratio of 2.9 when it surprised its shareholders with a 60% yearly EPS growth rate thereafter. I’m not attempting to compare a hosting company to a social networking site, but merely trying to depict a picture of constant surprises in the markets.
3. Power: 425 million active monthly users that spend an average of 3-5 hours a day on facebook’s platform translates to one thing – advertising power. Facebook has sheer power due to its user loyalty and brand recognition worldwide. I absolutely shrugged off GM’s recent cancellation of its $10 million ad campaign, dismissing it as an unhappy customer. GM is currently in a position where it cannot afford to have any wasteful spending on projects that don’t result in immediate profitability, so lets not be apt to blame Facebook just yet.
Per Comscore.com, there are approximately 5 trillion ad impressions displayed in the U.S. each year. Facebook has a market share of about 28%, which translates into 115 billion impressions per month. Its quarterly total display revenue is roughly $1 billion worldwide. Let’s face it, a loss of $10 million from one customer is not going to shift the tide, but it’s also not a drop in a bucket. As far as Facebook is concerned, there is not a doubt in my mind that tweaking the display ad platform to make it more efficient will be on the company’s top agenda in the upcoming quarters.
4. Revenue Diversification: What I love seeing from a company is its endeavor to diversify its income stream. This factor alone increases my personal EPS growth expectations. Facebook now began displaying ads on Zynga’s (NASDAQ: ZNGA) website, hinting at a possibility that one day it can run its own online advertising network. While I believe Google+ is not an imminent threat to Facebook’s business model, I wanted to shed light on Google’s (NASDAQ: GOOG) revenue stream that consists of 98% from online advertising, but earns ten times more a year than Facebook in net profit of $9.7 billion. Compare that to Facebook’s revenue stream of 85% from advertising and 12% from Zynga’s games. It also earns revenue from its members that want to market their business pages to a specific audience. By hiring new executives that had prior experience in Disney and Apple, the company is just getting started in expanding its advertising ventures.
Social and Political Impact
Facebook was not a pioneer in allowing friends and acquaintances around the world to stay in touch and share anything they wanted with each other for free, but it took the lead in an aggressive pace. There also have been numerous instances on Facebook where persons reunited after being apart 20+ years. It created relationships, marriages, and has been the center of attention in taking blame for many divorces. It also supercharged globalization in bolstering trade, allowing entrepeneurs to network and perform services across continents. In 2008 during the New Hampshire primary, Facebook allowed its users to give live feedback on political debates by the support of ABC and Saint Anselm College. Its success doesn't stop there, NSA and CIA consider Facebook as the number one source to gather information on criminals as the agents probably spend more hours on Facebook than we do.
Possibilities for facebook to branch out into new ventures are endless as long as it continues to keep its half a billion members addicted to its user friendly platform. I remain to be a strong bull on the stock until I see Google+ campaign ads influencing loyal users to switch.
edgarambart30 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Google. Motley Fool newsletter services recommend Google and Rackspace Hosting. 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.If you have questions about this post or the Fool’s blog network, click here for information.