The numbers are making the headlines all over the place aren’t they? How many times did you read about Facebook’s incredible 50 billion valuation even though the Goldman Sachs investment was very much in line with recent valuations. But Goldman Sachs, with its reputation, certainly gave credibility to that valuation. Many were shocked. But even more surprising to those was the fact that Goldman is being forced to shut down additional investors: there is simply too much demand for Facebook stock at that valuation.
Some have argued that the valuation was way out of line including this post that was probably looking more for attention than actually being serious. How could someone possibly compare P/E ratios for Facebook and Apple. Regular readers know how much of a believer I am in Apple. But they would also know that I consider Facebook to be the best investment out there. Yes, you heard me right. Facebook is not overvalued but quite the opposite, it remains a great deal opportunity.
Do you remember when a little search engine named Google decided to IPO? Many critics said its 85$ IPO was crazy and expensive for a company that had not proved how it could expand it pricing model. You can take a look at one article from 2004 from Business Week… does that bring back any memories? How do you think that turned out? I don’t think many doubt that Facebook will likely become as big and important as Google eventually as it quickly becomes the center of the web experience.
A look at the numbers
What many are bringing up is the estimated profits for Facebook in 2010, a respectable $500 million. So yes, the company is currently trading at a 100 P/E ratio. Expensive right? Some companies such as Open Table trade at even higher P/E’s. Comparing Apple’s P/E to Facebook’s is silly. Why? Because Facebook is growing at a very impressive pace and that is one of the most important factors when evaluating a P/E ratio. For example, it’s very realistic to expect that Facebook could increase profits by 100% in 2011 to $1 billion. That is not a stretch by most estimates. If that were to happen, investors that bought the current shares at a 100 P/E would now get twice as much earnings for the same value, or a 50 P/E. Add a few more years and you will see what I mean. As much as I like Apple, what are the odds that the company will double its profits in 2011? Zero….
Can Facebook keep up the growth?
If you agree with the analysis so far, the main question would be how much growth Facebook can sustain. As I’ve said in the past, Facebook is growing its revenues quickly, but not as quickly as its users because it is fully focused on the product rather than the profitability. I did suggest some things I would do if I were Mark Zuckerberg for a year but those will likely not happen as Facebook will continue to focus on the product. If Facebook were to focus on the revenues & profits, I would expect growth to be much higher than 100% in the first few years. But the company is focused on the long term and that is unlikely to change for some time (and why should it?).
So please stop the nonsense
I think that Goldman Sachs has been making a brilliant investment that will pay off in many different ways over the next few years and anyone who thinks the P/E ratio can come back here in a few years to discuss, I’ll be more than happy to take a look back!
Disclosure: I unfortunately do not have any positions on Facebook but have a long Apple position