Measuring the value of Facebook’s stock
What kind of an investment will Facebook Inc. shares become?
Facebook’s paperwork for an initial public stock offering spelled out a lot of the financial details of the company’s social media business. Investors now have a pretty good idea what they would be buying and that’s half the battle.
The other half is all about price and that remains an unknown. The eventual number of shares for sale and price of a stock are both subject to negotiation in an IPO process. Many estimates suggest Facebook hopes its stock offering will value the company at somewhere between $75 billion and $100 billion.
Once Facebook shares begin to trade in the public market - where most of us would get our initial opportunity to buy the stock - the price could go anywhere in the blink of an eye.
But the first thing professional investors pencil out is what they think a company is actually worth. That calculation is all about growth potential and earnings power. Facebook scores highly on both counts.
The IPO documents confirm that Facebook already makes a lot of money and continues to grow rapidly, a rare and coveted combination in public stock markets. Facebook’s commercial trajectory - and the fact that the company so dominates a business it practically invented - make comparisons difficult.
The only obvious point of reference is Google Inc.’s initial stock offering in 2004, an event that was every bit as big as Facebook’s IPO promises to become. More on that in a minute.
First, take a look at how much money Facebook makes. The company earned $1 billion in 2011, just its eighth year in business. Even more compelling, Facebook’s operations actually generated more than $1.5 billion in cash last year. Best of all: Facebook earned only $155 million in cash from its operations two years earlier. That important measure had increased by a factor of 10 in just two years.
Revenues at Facebook have also grown rapidly, from $777 million in 2009 to $3.7 billion last year. Those numbers are impressive, but not quite so dramatic.
Facebook IPO skeptics point out that the company’s stock sale will be much more expensive than Google’s offering eight years ago, based on an estimated price in relation to the company’s revenues.
Facebook shares could be priced at slightly more than 25 times the previous year’s sales if the company achieves a $100 billion valuation - a very rich calculation indeed. Google’s IPO shares were priced at about five times sales at the Internet search giant.
On the other hand, those two offerings are probably comparable when it comes to valuing a company in relation to profits. Facebook would be priced at something between 75 times and 100 times past earnings, based on valuation estimates. Google shares were valued at slightly more than 100 times earnings in their initial offering.
Those numbers are high, but not out of the question for profitable companies growing very rapidly. I’d focus on the profits and snap up a stock like Facebook if I could buy it for a price that works out to 75 times last year’s earnings. I’d sweat if the price approached 100 times earnings and run for my life if it cost even more to buy a little piece of Facebook.
This is a good time to confess that I haven’t always appreciated the true potential of very high growth companies. Eight years ago, I participated in the initial public offering of Google Inc. shares to write a story about the unusual stock-auction process Google employed to give smaller investors access to the IPO.
I was awarded four shares at the IPO price of $85 and sold them the next day for $98.70 each. To put it gently, I left some money on the table. Google briefly traded above $800 per share a few years later and closed yesterday at $585.11.
I sold those shares because the story was over. But I probably would have cashed out of a real investment much too early as well.
Google made good on its explosive growth potential once the company went public and rewarded investors (even though the stock is worth nearly 600 percent more, Google shares are only valued at about 14 times earnings forecast for 2012). I’m not sure Facebook will be able to match that kind of growth.
Stock prices are all about expectations for the future. Numbers that track performance in the past - even the immediate past - are helpful but not the things that matter most.
Facebook certainly faces growth challenges in the future. Among other things, it needs to increase advertising to millions of people who generally don’t care for ads.
But the company also has enormous strengths, a user base of more than 800 million spread across the world (Facebook says users in Europe and Asia outnumber the combined count in the United States and Canada).
Facebook stock doesn’t have to surpass Google’s track record to become a very good investment. It just has to be available at a price that makes sense.