Can This Social Media High-Flyer Continue to Trade Higher?

Facebook is now flirting with $45, trading with a market cap over $100 billion. While it's valuation is seemingly excessive, the big question is whether or not it can still trade higher? 

A bright future ahead
With 1.2 billion users, Facebook has the largest platform on the Internet, but the question has always been whether or not they could monetize those users.  

In recent quarters, the main concern has been the monetization of mobile. Yet, during their second quarter report , mobile ad revenue grew 75% over the previous quarter, making it 41% of total ad revenue.


With 50% top-line growth, Facebook looks well positioned, but it's the excitement surrounding new services that could take the company to the next level of growth.

Facebook is preparing to launch both a video advertising segment, and a payment system similar to PayPal. By my estimates (shown here ), Facebook could create $5 billion of additional revenue in its initial phases of launching these two services

Then, when you consider eBay's guidance for $9.5 billion-$10.5 billion in PayPal annual sales by 2015 , and that Facebook has more daily users than viewers of the Super Bowl, these new services could lead Facebook down the path of creating Google-like revenue over the next decade.

The tech world has been thrown into chaos as the biggest titans invade one another's turf. At stake is the future of a trillion-dollar revolution: mobile. To find out which of these giants is set to dominate the next decade, we've created a free report called "Who Will Win the War Between the 5 Biggest Tech Stocks?" Inside, you'll find out which companies are set to dominate, and we'll give in-the-know investors an edge. To grab a copy of this report, simply click here -- it's free!

The company's current growth, its outlook, and its new services, are all playing a part in the company's one-year 130% return.

How's it stack up?
Considering Facebook's place in its business cycle, the time in which it became a public company, and its growth, the company's closest competitor is most likely LinkedIn .

Both companies create large sums of revenue from advertising, but then have other services that make both companies unique.

Facebook is clearly larger with about six times as many users and five times more revenue. Yet, despite similar growth - LinkedIn grew revenue 59% in its last quarter - LinkedIn trades at 21.5 times sales compared to Facebook's price/sales ratio of 16.6.

For social media companies, which are mostly valued on future earnings and fundamentals, price times sales is often a good metric to determine a company's value.

While 21.5 times sales is extremely expensive, as is 16.6 for that matter, it is the standard of market excellence and optimism for social media companies. Hence, at 21.5 times sales, Facebook would have a market cap of $131 billion, or $54 a share.

Considering Facebook's outlook and recent trend, this ratio is highly attainable.

Understanding the cult
A "cult stock" is defined as having a sizable investor following despite somewhat insignificant fundamentals. In theory, these are speculative stocks, or those that are bought on potential. Immediately, companies such as LinkedIn, Workday, Netflix, or Tesla might come to mind, but truth be told, the label is fitting for most social media companies .

Among those in social media, I think both Yelp and Zillow fit the mold, along with LinkedIn.

Yelp has rallied 210% in 2013 alone. Almost a quarter of those gains followed Yelp's Q2 earnings report. In that quarter, revenue was just $55 million (69% gain over the prior year), and the company posted an EPS loss.

When you consider the company's $3.8 billion market cap, it is hard to justify a 50% rally behind $55 million in quarterly sales. Yet, the company's 20.4 times sales valuation appears almost meaningless to investors, and with 20% of its float being short, many believe there is still room to run even higher with short covering.

Zillow has rallied an even better 255% this year. The online real estate listing company had a decent quarter to start the year, but most of its gains have come without news and with optimism surrounding the housing market. The company has raised money several times including the issuance of 2.5 million shares back in August . Yet, this hasn't slowed down the stock, nor has its rising short interest, as Zillow now trades at 23 times sales.

For the ultimate case of irrational exuberance, LinkedIn announced a $1.2 billion stock offering and priced it at $223 . The next day, LinkedIn's stock rose 4% to nearly $250 due to whispers that the money could fund a high profile acquisition. These speculative gains show that seemingly nothing - not excessive valuation or dilution - can slow down these cult stocks. 

In the case of Facebook, this conversation is relevant because it appears to be on the road toward becoming a cult stock, if not already. Prior to July, Facebook could barely cross $26. Now, it's around $45, and has continuously trended higher since its quarterly report.

With most cult stocks having some catalyst that creates optimism, whether it be an acquisition, earnings, or guidance, a simple spark is all that's needed to create a multi-month (or year) rally.

Final Thoughts
In the case of social media cult stocks such as LinkedIn, Yelp, and Zillow, 20 times sales looks to be the norm, which leaves a lot of room for Facebook to trend higher.

With that said, it's hard to justify such a valuation as a good buy, as companies rarely maintain such a valuation for many years at a time. Yet, because of Facebook's outlook, it's likely to trade higher. Because although buying a stock at 16-20 times sales may contradict every rule you have about investing, in this particular space, this valuation is the standard. And clearly, Facebook is well on its way to meeting this standard.

The tech world has been thrown into chaos as the biggest titans invade one another's turf. At stake is the future of a trillion-dollar revolution: mobile. To find out which of these giants is set to dominate the next decade, we've created a free report called "Who Will Win the War Between the 5 Biggest Tech Stocks?" Inside, you'll find out which companies are set to dominate, and we'll give in-the-know investors an edge. To grab a copy of this report, simply click here -- it's free!


 
 
 
 
 
 
 
 
 

The article Can This Social Media High-Flyer Continue to Trade Higher? originally appeared on Fool.com.

Brian Nichols is long Facebook. The Motley Fool recommends Facebook, LinkedIn, and Zillow. The Motley Fool owns shares of Facebook, LinkedIn, and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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