Analysts Debate: Is Facebook a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "Motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Facebook (NAS: FB) , the massively popular social network.

Facebook by the numbers
Here's a quick snapshot of the company's most important numbers:

Statistic

Result (Most Recent Available)

Revenue (TTM) $4.04 billion
Net Income $972 million
Market Cap $93.1 billion
Cash and Equivalents / Debt $3.9 billion* / $706 million
P/E Ratio 78.6
Monthly Active Users 901 million
Daily Active Users 526 million
Mobile Users 488 million
Revenue From Advertising 82% for Q1 2012

Sources: Company S-1 filing, Morningstar, and Yahoo! Finance.
*Does not include proceeds from IPO. Adjusted pro forma expected cash balance is $10.3 billion.

Alex's take
Where do I even begin, and what do I leave for my fellow Fools to pick apart? Let's start with Facebook's close relationship with Zynga (NAS: ZNGA) , a company we've unanimously rejected for many reasons. The 18% of non-advertising revenue Facebook earned in the first quarter came largely from a gaming company that seems primarily designed to exploit those with weak wills and big pocketbooks, and a measurable chunk of ad revenue came from Zynga pages, too. Last quarter, Zynga brought Facebook 11% of its non-advertising revenue and 4% of its advertising revenue. The one bright spot here is that this percentage is down from Zynga's 19% contribution to Facebook's total 2011 revenue.

More worrying is Facebook's faceplant on mobile functionality. Between 470 million and 490 million smartphones sold last year. You might have Facebook on yours. I do. It doesn't show ads. It doesn't play games. The only thing it does is allow me to read or comment on my friends' status updates when I'm not at my computer, offering a stream of information that's supposedly very valuable for advertisers -- if they could only use it to advertise on Facebook Mobile.

Facebook's existing ads haven't even proved their value yet relative to major competitors. Facebook's ads get clicked once every 2,000 times they're served, compared with Google's (NAS: GOOG) rate of once per 250 views and an industry average of once every 1,000 views. Major Facebook brand pages -- with more than 100,000 fans -- generate one clickthrough on links posted to that brand's feed per 715 views, despite having a large and presumably interested audience. Keep in mind that not every link will be seen by all that brand's fans, only by those who check their feed within certain timeframes and under certain visibility settings. If you were looking for some numbers to explain why General Motors (NYS: GM) pulled out of its Facebook efforts, there they are.

Let's assume that Facebook miraculously develops an amazing mobile ad platform and doubles its profitability as a result. If nothing else happens, the company's P/E would then be close to 40. The site's 901 million active monthly users add up to 40% of the entire global connected population. How many now active will remain so, and how many new members will join, if (or as) Facebook's revenue generation gets more apparent and more obnoxious? The upper boundary of this growth story, as has typically been the case for previous social networks, is unlikely territory.

With an imperial CEO flaunting the Street's overtures and murmurs of Facebook fatigue setting in, it's hard to see this stock maintaining its current levels, depressed as they already are from a weak IPO. I'm going out on a limb and calling this the flop of 2012.

Sean's take
I couldn't put my finger on it, but it's like you almost knew that something was going to go epically wrong once Facebook shares made it to the public arena. If anything, the drop over the past few days points to the dangers of trading in highly illiquid secondary markets like SharesPost. I'm not saying secondary markets don't serve a purpose, but I am saying they're no place for a novice investor.

Facebook itself is a cutting-edge social platform that has garnered 901 million users and still has a lot of room to grow internationally. It has only begun to tap its available cash-generating resources, meaning there are multiple avenues of growth available regardless of the path Facebook takes. However, there's still a mountain of unanswered questions that scare the daylights out of me.

For one, how exactly is Facebook going to translate a mobile revolution into bottom-line profits? According to Facebook's developers page, more than 425 million users access Facebook from a mobile device. However, none of these 425 million users are seeing advertisements directed at them and are nothing more than a missed opportunity for a company that relied on advertising to provide 82% of its revenue in the latest quarter.

What has me extremely worried is Mark Zuckerberg's 57% controlling stake in the company. I'm not saying Zuckerberg hasn't done a great job thus far, but I'm concerned that shareholder interests will be thrown to the back burner if they don't align with Zuckerberg's vision of Facebook in the future.

When all is said and done, Facebook insiders sold considerably more than Google when it came to market, and rightfully so, as the valuation just doesn't make sense. Even at its "reduced rate" of just 47 times forward earnings, I have a very hard time justifying paying 23 times sales for a company so reliant on advertising rates. Until it fixes some of my key concerns, it remains a pound-the-table sell in my books.

Travis' take
I can't believe I'm saying this, but after the crash we've seen in Facebook's shares this week I'm starting to rethink my initially bearish stance on the company's shares. I had actually planned to short the stock if shares popped on Friday and would still have been happy to short at $38 on Monday, but the stock has crashed through that level, and I'm left without a position as I re-evaluate the future of the stock.

Alex and Sean have pointed out some of the company's negatives, and I won't disagree with any of them. But they're glossing over some positives I think the company possesses long-term. Unlike recent IPOs like Groupon, Pandora, and Zynga, the company actually makes money -- a lot of money. Net income of $972 million was generated in the past 12 months on revenue of $4.04 billion, translating to an incredible 24% net margin. That's nothing to sneeze at in a company as young and growing as Facebook.

The company is also just learning how to make money, much like Google in its early days as a public company. Sure, mobile doesn't include ads now, but it probably will soon. Even the company's regular advertising has room to grow and improve. And there are new revenue sources that will pop up in the future. Facebook has explored opening up to online gaming in the U.K. and when it is finally legalized in the United States. Zynga has a shot at taking significant market share. Game developers are just starting to leverage Facebook's revenue-generating potential, and there's no reason to think that avenue couldn't grow as well. I'm sure there are other revenue generators the team will come up with down the road that those of us outside the business aren't even considering.

When we look at valuation, following the IPO the company is flush with cash, totaling around $10 billion. So at the very least the company is worth that, to put a floor on things. If we put a high but reasonable 50 multiple on trailing earnings and add $10 billion in cash, I get a market cap of around $60 billion, or $22 per share. I would be willing to buy shares at that price, and at the rate they're falling it might not be far off.

I'm not one to argue with the bearish view of Facebook right now, because I have Facebook fatigue. I don't click on its ads, and I think Facebook is closer to the last thing than the next thing. But we can't completely discount the stock if it falls into the mid-$20 range. The company has woven its way into the fabric of our society and become one of the few company names that can be used as a noun and a verb.

I would prefer to give an underperform call with a limit order at $35 rather than where it is trading at and would even give the stock a green thumbs-up at $22 per share if we go that low.

The final call
With two of us looking to un-"like" this social network and Travis waiting for a better bargain, it looks like this one will go in the books as an underperform CAPScall for our TMFYoungGuns CAPS portfolio. If the market gets a bad case of Facebook fatigue, we might be willing to revisit this pick and change our minds, but it won't be for a while yet. But you don't have to wait to discover the hidden tech gem in Facebook's shadow. Its secret is laid bare in The Motley Fool's latest free report, available for a limited time to social-savvy investors (or just those with the financial savvy that really matters). Get the free information you need to make a new friend for your portfolio.

At the time this article was published Fool contributors Travis Hoium, Alex Planes, and Sean Williams have no positions in any companies mentioned. You can follow Travis on Twitter at @FlushDrawFool, Sean at @TMFUltraLong, and Alex at @TMFBiggles. The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of General Motors and Google. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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Larry

http://bit.ly/Kqa9yI

May 23 2012 at 9:35 PM Report abuse rate up rate down Reply
Larry

Is FB a top stock? http://bit.ly/Kqa9yI

May 23 2012 at 9:35 PM Report abuse rate up rate down Reply