Has Facebook Found A Bottom?

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

After having an IPO price of $42.00 per share, the share price of Facebook (NASDAQ: FB) continued to fall for months until it bottomed at $17.55. Once the share price found the bottom, it rallied all the way up to $32.46 even though it started to fall again. Two and half months after reaching peak, Facebook shares currently trade for around $26 which means that the share price is down by 20% since then. Did Facebook find a bottom?

Is Facebook Expensive?

Whenever Facebook is mentioned in the investment world, a lot of people point out that the shares of the company are too expensive given the company's current earnings. In contrast, those who are bullish on Facebook mention how they are more concerned with Facebook's future earnings rather than past earnings. After all, share price of companies is mostly determined by expected earnings rather than achieved earnings. Many times, a company will beat estimates by a large margin, but see its share price plunge because of a bad future guidance; whereas many times a company will fail to beat estimates but still see a rally in its share price because of a good future guidance. The stock market is future oriented.

Analysts Are Optimistic

Having said that, Facebook will continue to be expensive for years to come, because even if the company doubles its earnings every year for the next 5 years while the share price remains flat during the same period, it will still trade for a higher than average P/E ratio. On the other hand, many analysts are highly optimistic of the company. Currently, out of the 29 analysts covering the stock, 15 rate it as "strong buy," 3 rate it as "buy," and 11 rate it as "hold." Interestingly enough, there are no analysts who rate the company as either "underperform" or "sell." The average rating on the company is "strong buy." Furthermore, the average target price on Facebook is $34, which indicates an upside of 35% on the current price of the company. The analysts expect Facebook to earn 38 cents per share in 2013, 48 cents per share in 2014, 60 cents per share in 2015 and $1.42 per share in 2016. Even if we look at Facebook's 2006 estimates, we are still looking at a forward P/E ratio of 18. Then why are analysts so optimistic of this company?

Facebook's Most Valuable Asset

There are encouraging points for the company and its investors. Keep in mind that Facebook owns a lot of valuable data. So far, the company has acquired useful personal information of every 5th person in the world above the age of 12. This is the kind of personal information that marketing companies are drooling over. In the world, only Google (NASDAQ: GOOG) has the kind of database of humans that can rival the database of Facebook. While many marketing companies that operate on the internet have to guess someone's gender, age, ethnicity and interests based on their internet habits, keyword usage and surfing history, the users give all this information to Facebook voluntarily. If the company uses the information intelligently, the sky is the limit in terms of opportunities.

Mark Zuckerberg Is Learning His Lesson

Once the product started to improve, Mr. Zuckerberg started to put more emphasis on monetizing the product. One of the biggest challenges in front of Facebook was the immigration of users from PCs to mobile devices, because the company was not aware of a way of monetizing users on mobile devices. The small screen of mobile devices made it difficult to fit content and money-generating ads at the same time. The company found a brilliant way to battle this issue as it inserted hidden ads in people's newsfeed. Many people didn't even realize that they were receiving ads on their mobile device. At the end of the day, the company accomplished the difficult task of finding a solution that would make both users and advertisement companies happy.

Opportunities Are Limitless

Now, there are many opportunities in front of Facebook in order for the company to grow its earnings without needing to increase the number of users. The company has already been experimenting with some of these opportunities. For example, Facebook started to charge people $1 to send a message to inbox of a user who they are not friends with. This may or may not work in the long run, but at least the company is trying to find creative ways to monetize its huge user base. In the future, I wouldn't be surprised if users are forced to watch a short advertisement every time they log in to their Facebook account. YouTube has been doing this with many videos, and it's been working for the company so far. Facebook continues to engage its users. For example, on average, Facebook users log in to check their page 14 times a day. In order for Facebook to lose popularity, a better alternative would have to come up; however, it hasn't happened in the last few years. Some alternatives to Facebook, such as Twitter and Instagram, are fully integrated with Facebook, which makes it less likely that the company's popularity will go down anytime soon.

Conclusion

But all this doesn't answer one main question. Is Facebook bottoming in the short term? Currently, 32 million of the company's shares are shorted, which is more than the 20 million shorted shares in the beginning of the year; however, much less than the 95 million shares that were shorted back in November. While most short sellers know that Facebook is overvalued as it is, they are also afraid that the company's share price can shoot up significantly on short notice. Currently, institutional ownership of Facebook is at 34%, which is very low for a company that is highly recommended by analysts. The low rate can mean two things for the company, 1) there are a lot of potential institutional buyers for the stock if a catalyst occurs, 2) the stock will continue to have high volatility as most stocks are when their institutional ownership rate is low.

I am tempted to give Facebook a chance by purchasing some shares; however, if I do such a thing, I will make sure to write calls on my shares on monthly basis in order to bring my breakeven price down, and I will only hold the stock for a year or two at most, until the dust settles and the direction of the company becomes clearer. This company can be a good speculative play for younger investors who have higher tolerance for short term loss. More conservative investors can find value elsewhere.


Jacob Steinberg owns shares of Google. The Motley Fool recommends Amazon.com, eBay, Facebook, and Google. The Motley Fool owns shares of Amazon.com, eBay, Facebook, and Google. 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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