By Jack Hough
Facebook shares plunged nearly 10% Tuesday to close at $28.84. They now sit 24% lower than the $38 price the company fetched in its initial stock offering earlier this month.
Readers of this space found plenty of reasons to stay clear of the stock at its debut and shortly after (see “What Facebook’s IPO and Treasurys Have in Common” and “3 Reasons Facebook Stock Won’t Soar”). But at what price may shares safely be considered cheap?
It’s impossible to say with precision, considering that much of Facebook’s price is based on expected growth. But here’s one way for investors to frame their thinking.
Start by comparing prices and revenues for Facebook and Google. Google is a good choice for the job because both it and Facebook are thriving, cash-rich dotcom businesses with high margins. Also, Google offers a look ahead at how Facebook’s stock might trade once the latter’s revenue growth slows.
Google shares closed Tuesday at 4.9 times the company’s revenues for the four quarters ended March 31, and Facebook, 15.3 times revenues for the same period. One reason Facebook is more than three times as expensive as Google is that it’s growing much faster. In the first quarter of this year, Facebook increased revenues by 71% from a year prior, versus 28% for Google.
Now assume that at some point in coming years, as Facebook’s revenue growth slows, its price-to-revenues ratio will shrink to look more like Google’s today.
Next, look at the revenue projections for both companies (see table). They come from FactSet Research Systems and are based on a poll of Wall Street analysts. Note that 29 analysts contribute to Google’s 2012 revenue consensus but only six contribute to its 2016 one. For Facebook, the numbers are 12 and seven.
There’s a reason fewer analysts issue forecasts for distant years: Many consider it futile to try to predict results that far into the future. Investors should keep this rising level of uncertainty for longer forecasts in mind.
An extreme Facebook skeptic might say that the company’s fast revenue growth won’t last long, and that its stock should therefore be priced in line with Google’s valuation of 4.9 times revenues. Multiplying that by Facebook’s revenues for the past four quarters works out to $19.6 billion. That would put Facebook stock at $9 and change. Few investors are that bearish on the company, however.
An investor who’s merely lukewarm on Facebook’s growth prospects might say that the company will meet its revenue forecasts in the early years but then converge on a Google-like valuation thereafter. For example, Google trades at 2.9 times its projected 2014 revenues. Facebook is expected to deliver $8.65 billion in revenues that year. Multiply one number by the other and the result is a market value of $25.1 billion for Facebook. That’s close to $12 a share.
A more bullish approach: Count on Facebook to deliver all of its expected growth through 2016, but apply Google’s valuation to that year’s projection. That gives Facebook a current market value of $33.1 billion, or a stock price of $15 and change.
The investor who pays Tuesday’s closing price of $28.84, meanwhile, is betting not only that Facebook will deliver on all that revenue growth through 2016, but also that its price-to-revenues ratio in that year will remain much higher than Google’s in anticipation of many more years of blazing growth to come.
It’s a possible outcome, but it’s not one that cautious investors should bet on.