Price, Earning, and $10/share Facebook

View 725 Monday, May 21, 2012

The tumult and the shouting dies, the Goldman Sachs and the Sovereign funds depart…

Which is to say that the Facebook IPO is over, and on today’s trading those who invested money in the notion that Facebook is worth 40 or more times earnings per share have lost money. I don’t know why anyone would be surprised. Think on it: if you bought Facebook at the initial price of $38 (and thus put money in the bank for the founders, employees, and early private investors in Facebook who certainly would like to have your money) you have bought paper that Facebook will need forty years to be able to buy back. The alternative is that Facebook will cleverly invest its earnings in a way that causes other people to buy that paper for what you paid for it. Or that enough people out there will decide that this is such a good deal they have to get in on it, and they will bid more for your paper than you paid.

By contrast, Apple is trading at about ten times earnings, and Google trades at about 12 time earnings.

Of course Facebook can grow. It only has a billion members. It can get more. Surely there is great potential for growth here. And we can advertise to them, and companies will pay to run those ads. Facebook shares will rise, double in value –

And thus are bubbles created, but it didn’t happen that way. Facebook is now down to below the initial offering price, and is likely to fall more. Those whose orders got lost by the buggy NASDAQ software and thus didn’t get in on the IPO turn out to be lucky. Even more lucky – or astute – would be the initial stockholders who sold out at the IPO price – at least it certainly looks that way. I would think that the end of the hype is the end of the Facebook bubble, and the price will continue to fall until Facebook is down in the region of ten times earnings. Even at that it will take Facebook ten years to earn enough to buy your share (just as it takes Apple or Google that long to make enough to earn enough to buy their own shares. Which is to say that given current earnings, Facebook would be worth about $38/4 which is to say less than $10 a share.

Will it fall that far? Who knows, really? But without a lot more expected revenue – either for real, or expected from exciting new ideas in converting that huge membership to a revenue source, either directly or through buying something that can be advertised on Facebook – it’s highly unlikely. Microsoft shot up from its first days after going public because Gates had the vision of a computer on every desk, and in every home, and in every classroom, and Microsoft software running on every one of those computers; and Microsoft pretty well achieved that. Apple almost died until the Return of King Jobs with his visions of smart phones and elegant tablets brought it back from a minor player to a giant worth ten or twelve times earnings, and stays there partly because of momentum and partly because Jobs infused Apple with his vision of how to take the inevitable new technology and make it something everyone wanted. Google is there because – well, that depends on to whom you listen. But for Apple, or Microsoft, or Google to get up above 20 times earnings is going to take a lot of vision along with the razzle-dazzle to sell it.

There was a time when people bought stock based on expected dividends. American tax laws have made it far more worthwhile for corporations to use their revenues to increase the value of their stock rather than concentrate on long term steady profits and dividends. That encourages speculation and bubbles – you pay less tax on money ‘earned’ by razzle-dazzle than on income from making good stuff and selling it at a profit. The result is that companies devour each other, buy their competition, and generally do whatever they can to increase capital gains. One remedy would be to tax interest, dividends, and capital gains at the same rates – after all, they are returns on investments made with money you’ve already paid taxes on – but that doesn’t seem to be in the realm of political possibilities. Thus we have all this focus on growth and razzle-dazzle, and not much on just building a solid company that makes stuff people want and will buy.

That’s not the way capitalism is supposed to work, but it’s what we have.