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Will Facebook Do Better in 2013?

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

Very few companies will be happier to put 2012 behind them than Facebook (NASDAQ: FB). Was it only a year ago that it was the most highly anticipated IPO of all time, with real-money trades in private markets putting a valuation of over $100 billion on the company? Even with a respectable rally in November Facebook is down about 32% from its IPO price and is currently valued at $56 billion. Concerns about privacy and changes to the site’s interface abound, though that’s nothing new. Recent attempts to monetize traffic either look like grasping at straws- $1 to send a message to a stranger, $7 to “promote” a status update- or have resulted in a black eye for the company as with its Instagram debacle. Considering that Facebook trades at 40 times forward earnings estimates, it needs strategies to grow its earnings and thus far we’re not that confident management is making progress there.

Facebook’s revenue was up 32% last quarter compared to the third quarter of 2011, which was roughly the same growth rate that the company had experienced on the top line in the first half of the year. However, thanks in part to an increase in share-based compensation (notably in R&D, where expenses more than doubled from a year earlier), pretax income was about flat. We’ve mentioned the high earnings multiple; Facebook also looks expensive with an enterprise value equal to 10 times trailing revenue.

Facebook was one of the ten most popular tech stocks among hedge funds in the third quarter of 2012 (see the top ten rankings), and while we hadn’t considered the stock a buy at the time those managers likely caught the recent rally- though they may have ridden the stock down during the third quarter, of course. Tiger Global Management reported owning nearly 12 million shares of the stock (find Tiger Global's favorite stocks) while Viking Global, which is managed by fellow Tiger Cub Andreas Halvorsen, initiated a position of 4.2 million shares (check out Halvorsen's stock picks).

We think that Facebook is best compared to Google (NASDAQ: GOOG), which owns the Google Plus social network, and to Linkedin (NYSE: LNKD). LinkedIn’s multiples are even higher than Facebook’s- it trades at 88 times forward earnings estimates, and that figure depends on higher earnings growth next year. It has been seeing very high revenue growth and it at least is selling viable subscription products, but we don’t think it’s a good value and believe that the market may be overvaluing it. Google carries a forward P/E of 15; this also comes with optimism for 2013 though the core Google business is improving and the company should be able to realize some efficiencies as it integrates Motorola Mobility Holdings. We’re looking forward to considering Google more closely after its next quarterly report.

Facebook can also be compared to disappointing recent IPOs Groupon (NASDAQ: GRPN) and Zynga (NASDAQ: ZNGA), the latter of which still uses Facebook for much of its gaming traffic. Both of these companies are struggling with profitability, and Zynga in particular is in serious trouble with the majority of its market cap being its cash position. It might be a small short- the company itself is unattractive, but there is a risk that it would be acquired by another tech company. Groupon, like Facebook, has rebounded from its lows- though the stock is still down 76% from a year ago- and its forward P/E is 20. It too is a popular short, and we’re certainly not very optimistic about the business, but there is enough of an upside if it actually hits its earnings targets that we would avoid taking any position.

We don’t think that Facebook is a buy for 2013. Unless the company finds a way to grow its earnings, it is going to end up significantly overvalued at the current price. While we wouldn’t completely discount the possibility of that happening- and would hesitate to actually be short- we’re not impressed with the monetization plans it has put forth since going public and don’t think investors should buy either.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has a long position in GOOG. 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!

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