How Much is Facebook Worth?

So now that Facebook ($FB) is public, is the stock a good buy?

The short answer is no. The longer answer is noooooooo.

First we have to consider the fact that no company has ever gone public because they thought their share price was too low. That shouldn’t dismiss every initial public offering, but it’s an important consideration to keep in mind. As a general rule, IPOs are bad buys.

The other fact is that it’s very difficult to evaluate the prospects of a young company in a new industry. I have a pretty good idea of how quickly Medtronic ($MDT) will grow its earnings over the next few years. I can’t say the same for Facebook. More than 12 years after its peak, Yahoo’s ($YHOO) share price is barely one-eighth its price. Things didn’t turn out as they were planned.

We also know that FB’s underwriters spent enormous amounts of money trying to keep the stock price above $38 on Friday.

Some market participants said that the underwriters had to absorb mountains of stock to defend the $38 level and keep the market from dipping below it.

The firm did this by tapping into a 63 million share over-allotment option, or greenshoe, according to sources familiar with the deal.

As an indication of the cost, had Morgan Stanley bought all of the shares traded around $38 in the final 20 minutes of the day, it would have spent nearly $2 billion. Underwriters are not obligated to prop up a stock on debut, but typically do.

Morgan Stanley declined to comment.

I don’t see why it’s so embarrassing for FB to drop below its offering price. Or at least why that embarrassment is worth more than $2 billion. As a side note, I’m also not bothered by the delay in starting trading in Facebook. That’s slightly embarrassing, but I’d rather that they get it right rather than get it on time. Big deal; traders can wait 20 minutes.

Now let’s look at some of the projections about Facebook and we’ll use our World’s Simplest Stock Valuation Method. Wall Street currently thinks the company will earn 60 cents per share next year. Henry Blodget thinks that’s way too low and that FB can earn $1 per share in 2013. I think that’s a much more reasonable assumption.

I haven’t seen any estimates of Facebook’s five-year growth rate so we’ll have to use some creativity here. We do know that Facebook’s growth rate is falling, but of course that’s from unsustainable levels to more realistic ones. One hint is that last quarter the company grew its revenue by 44%.

To be safe, let’s use a 50% earnings growth rate for the next five year. That’s almost certainly too high, but again, we’re being safe.

The World Simplest Stock Valuation Method is:

Price/Earnings Ratio = Growth Rate/2 + 8

So that works out to:

33 = 50/2 + 8

And with a $1 per share estimate for next year, that works out to a fair value of $33. So by using numbers very favorable to Facebook we can see that the stock is overpriced. On top of that, as a prudent investor, I wouldn’t be interested in Facebook unless it’s going for 30% below Fair Value. That’s about $23 per share.

For now, I’m keeping my distance from Facebook.

Posted by on May 21st, 2012 at 8:26 am

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