lindley (1)

Business Insider

Lindley Estes is a business writer for The Free Lance-Star and This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.

RSS feed of this blog

Facebook fiasco a teaching moment

It seems like somewhat of a cheap shot to jump on the crowded bandwagon of pundits ripping Facebook for the way it handled its initial public stock offering May 18, but I couldn’t resist the opportunity to use the situation as a cautionary investment tale.

Facebook’s IPO was one of the most-hyped in history. That wasn’t the fault of reticent young CEO Mark Zuckerberg, who probably would have preferred to keep the company private were that possible. There was intense interest and hence media coverage in the IPO due in large part to the fact that just about everyone uses Facebook, so it was a company people felt they understood. That familiarity, bolstered by the Hollywood movie “The Social Network,” also probably contributed to the perception of Facebook’s potential for stunning growth. And that led investors to line up for the IPO.

But once the hype faded and professional investors took over, the reality set in: Facebook is hugely overvalued compared to its peers based on current earnings. And that was probably behind the stock’s decline from its $38 per share IPO price to under $30 a share late last week, a fall that shaved tens of billions off the company’s market cap (much of which belongs to Zuckerberg).

Research provided by longtime area stockbroker Don Newlin of Sterne Agee shows just how overvalued Facebook is compared to three other well-known but more mature tech titans: Apple, Google and Microsoft.

Late this past week Facebook was trading for about 89 times its 2011 earnings per share. By contrast Microsoft (10.5 P/E), Apple (14) and Google (18)—all of which have growing earnings that dwarf Facebook’s—were trading for much more realistic levels. Another way to look at it: If Facebook were trading for Apple’s P/E, its stock would sell for around five bucks a share.


Of course what investors really want is growth, and it could be argued that Facebook has more potential for that due to its youth. It’s not hard to imagine the ways in which Facebook’s revenues could grow, and some of the early investors were willing to buy the pricey lottery ticket to take a chance it would pan out.

They could ultimately be proved right. Indeed, it’s very reminiscent of’s sky-high valuation during the dotcom bubble in the late 1990s. At that point Amazon didn’t have the earnings to justify its P/E, but over time it has grown into the valuation due to a superb business model (though Amazon’s P/E, at about 175, is still almost double even Facebook’s).

But there’s no guarantee Facebook will ever figure out a way to really monetize its vast user base. While guarantee isn’t a word that applies to most investments, it’s sheer speculation to buy a stock that has so little current earnings relative to its price based on the assumption that those earnings will someday materialize.

Further, the Facebook début should be a cautionary tale not to jump into a stock just because the company provides a product that you use and understand. A lot of people who load up their 401(k)s with their own company’s stock make the same mistake.

Zuckerberg and crew may get the last laugh. But at this point it seems wise for prudent investors to look for a more reasonably priced company that not only has decent prospects for the future but also substantial earnings in the present.

Post tags: