Why Facebook Deserves a Spot in Your Portfolio

Howard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Not many stocks have divided investors as much as Facebook (NASDAQ: FB) has. Those with bearish outlooks quickly point out the current limited money-making model, overvaluation, or that the EPS has declined ever since the IPO. Yet there are still strong believers in Facebook, and have been since day one. On Tuesday Facebook announced their new search engine, Graph Search, which CEO Mark Zuckerberg says is “the third pillar of Facebook, complementing News Feed and Timeline. Graph Search will allow users to ask real time questions to find friends and information within the Facebook universe.” This is the first tool that Facebook has released that shows they are transforming the social media website with a new business model, and it now makes Facebook a buy.

A Few Fundamentals

Facebook is currently valued at a P/E of 154, a pretty steep price. Facebook's first quarter in December of 2011 posted revenue of $1.13 billion, and the latest earnings as of September 2012 are $1.26 billion. EPS, however, has steadily declined. In their first quarter EPS was $0.13, but in their latest quarter EPS has declined to $-0.02. The analysts are looking for a good fiscal year for Facebook in 2013, projecting $0.46 EPS. Currently they have a profit margin of 6.26%, $902 million in debt, and $1.4 billion in free cash flow. What this tells me is that Facebook is a company that is highly valued, increasing its revenue, continuing to grow, and has lots of cash available.

Why The Fundamentals Don’t Matter

While the hard numbers of fundamentals are extremely useful investing tools, for a company like Facebook they do not tell the whole story. Facebook is a buy not because of the fundamentals, but because of the intangibles they possess. Facebook is a company with huge potential in front of it, and fundamentals like P/E are not as important because no one know exactly how to value a social networking business. But even so, we do know that Facebook has built upon websites before it like MySpace and was able to make it into a profitable business where other websites did not.

Because of that, Facebook is almost unrivaled in competition, with its biggest competitor being LinkedIn (NYSE: LNKD), the popular networking site for job employers, recruiters, and job seekers. While the two may not be the same concept, Facebook should be looking into tapping into its massive user base to connect potential employees and employers. This is just one example of the many ways Facebook can expand to a business that does not just rely on ad revenue. Even though some say that the IPO of Facebook was a failure, they still managed to raise billions of dollars. This large amount of money is just waiting to be used to finance new business ideas (Facebook phone?) and to buy up smaller companies like we saw with the buyout of Instagram. We may have just seen the adding to the Facebook arsenal this week with what is essentially a “Facebook search engine.”

Of course driving all of this is the founder of Facebook, CEO Mark Zuckerberg. Zuckerberg is not the prototypical CEO that we see in blue chip companies, but a young innovative CEO who has built his company from the ground up and has his sights set higher. Facebook has been able to continue growing with models like "Gifts." Gifts allow users to purchase a gift for friends online, and the gift will then be posted on their wall and shipped in the mail. Gifts gives Facebook access to the over-$30 billion a year market of online gifts. Even if they charge 10% of revenue for selling products, gifts could easily out-earn their revenue per user from ads, which is $4.34 per global user and $9.51 per US user. With Facebook being such a large market, retailers may be glad to pay more than 10% of revenue just for the added exposure. Amazon (NASDAQ: AMZN) is an example of the potential upside that the gifts service could provide. Amazon currently has 100,000,000 active accounts on their website, and the company brings in $54 million in revenue per day. While becoming a new Amazon is a long shot for Facebook, Gifts easy, almost one-click way of buying shipping, and notifying friends of their gifts could be a simple alternative for shoppers. While it is too early to tell how Gifts will sell, we do know that Facebook has access to a potential customer base of 1 billion people; thats 14% of the population and 10 times larger than Amazon's active accounts.

My Conclusion

The way I see it, Facebook has enormous potential to grow and become the king of the internet. People love posting information on Facebook and companies love getting their hands on that information, generating Facebook ad revenues of $4 per user worldwide. If Facebook can successfully set up a “Facebook mall” we could be looking at a company that could have a fighting chance of taking on the internet retail giant that is Amazon. Whether or not Facebook could become this combination of social media and Amazon, only time will tell; but the only way to profit is to buy now.

Hjcranford has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Facebook, Google, and LinkedIn. The Motley Fool owns shares of Amazon.com, 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!

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