Facebook is finally a buy at ...May 29, 2012: 4:01 PM ET
Facebook shares continue to plummet. Shares plunged nearly 10% Tuesday, falling below the $29 level. The stock is now about 24% below its offering price of $38. That makes it officially a bear market for the social network. But guess what? It's likely to get worse for Facebook (FB) before it gets better.
It's easier to make that case now, since we are starting to get a slow trickle of earnings and revenue forecasts for Facebook.
Analysts at firms who were underwriters for the IPO are not allowed to officially start coverage on the stock for another few weeks -- although it looks like bearish remarks from lead banker Morgan Stanley (MS) have already led to shareholder lawsuits.
Brokerages that were not part of the Facebook offering are free to issue reports on the stock. Because of the intense interest in Zuckerberg & Co., there already is a critical mass of coverage and earnings estimates. Ten analysts have earnings forecasts for 2012.
For what it's worth, the median price target on the stock is $42, 40% higher than the current price. Analysts are forecasting earnings growth, on average, over the next three to five years of about 36% a year.
In other words, Facebook has a lot to live up to in order to satisfy Wall Street's so-called sell side. That's why many investors are still shying away from the stock.
I spoke with four fund managers Tuesday who all have big exposure to the tech sector. Not one of them said they are tempted to buy Facebook's stock yet. They all said the shares remain extremely overvalued.
"We have not invested in Facebook. Here's the reason: Growth expectations are high, and the company would have had to do a number things flawlessly to meet them over the next few years. There is no point investing in them this early," said Sunil Reddy, portfolio manager with Apex Capital Management in Dayton, Ohio.
Reddy said that he prefers Google (GOOG) to Facebook. Facebook trades at more than 50 times 2012 forecasts while Google trades at just 13.7 times 2012 earnings estimates. If you take that multiple and apply it to Facebook's consensus earnings estimate of 55 cents a share for 2012, you get a Facebook stock price of only $7.56! That's nearly 75% below its current price.
Of course, that probably is too bearish of a prediction. Facebook is still a solid company with strong growth prospects. It's not a fly-by-night tech destined for obsolescence; it just didn't deserve to be worth more than $100 billion on day 1 as a public company.
Jason McPharlin, portfolio manager with Rushmore Investment Advisors in Plano, Texas, agreed with Reddy that there are many better bargains. "We like tech a lot. But there is good value elsewhere in the sector," he said. His firm owns Apple (AAPL), Google, Intel (INTC), IBM (IBM), Oracle (ORCL) and Qualcomm (QCOM).
McPharlin said he'd be tempted to buy the stock if it began trading at a discount to Wall Street's projected long-term growth rate. Many tech investors use what's known as a price-to-earnings growth, or PEG ratio, to value tech stocks. Basically, it's the P/E ratio on current estimates divided by the long-term growth rate.
On that basis, Facebook could justifiably trade at 36 times 2012 profit forecasts of 55 cents a share. That's a big premium to Google as well as other prominent tech stocks. Most of the tech stocks McPharlin owns trade at a PEG ratio below 1.
IBM, at 1.3, has the highest PEG in McPharlin's group. At a PEG of 1 for Facebook, you'd be looking at a stock price of $19.80. Even if you were feeling charitable and wanted to say Faecbook deserves a Big Blue PEG of 1.3, that still only values the stock at a little below $26.
In addition, it's not clear how analysts come up with the 36% long-term growth rate to begin with. The consensus for 2012 is for earnings to increase by 27% from last year. Analysts are forecasting a year-over-year profit increase of 20% in 2013. Sure, Facebook is looking to do more to boost its mobile ad revenue prospects -- there's even speculation that it could buy Norwegian mobile browser maker Opera Software for more than $1 billion to supplement its Instagram purchase. But unless 2014, 2015 and 2016 are ridiculously good years for Facebook, it's tough to imagine how the company will meet the current lofty long-term forecasts.
Bob Bacarella, manager of the Monetta Fund (MONTX) in Wheaton, Ill., cites this uncertainty as a big reason why he's avoiding the stock. Bacarella, who said Apple and Google are top holdings in his fund, said that Facebook still looks more like "hype" and a "concept" to him.
"It's hard to get your arms around the fundamentals," he said. "This isn't to say that Facebook stock can't do well three or four years from now. But I'd give it time to settle. I am not sure how to value it."
Oliver Pursche, co-manager of the GMG Defensive Beta Fund (MPDAX) in Suffern, N.Y., added that even if you choose to ignore earnings and focus on sales instead, it's difficult to justify the current price.
"We will keep an eye on Facebook. We would be open to investing in at some point. But it all comes down to valuation," said Pursche. His fund owns Google, Intel, Microsoft (MSFT) and IBM.
Analysts are forecasting revenue of nearly $5 billion for Facebook this year. Based on its current market valuation of about $64 billion (using a share count of 2.1 billion and not the 2.8 billion shares Facebook may eventually have after options are exercised) that is a price-to-sales ratio of nearly 13.
Apple has a price-to-sales ratio of only 3 times fiscal 2012 estimates. Google trades at 5.5 times 2012 revenue estimates. Even if you want to assume that Facebook deserves some premium to Apple and Google, should it be this much of a premium? At 8 times 2012 revenue forecasts, which would still be rich, Facebook's market value would work out to about $40 billion, or around $19 a share.
So don't get tempted into thinking Facebook is a buy now that it has dipped below $30. You may be better off waiting for it to go below $20 before taking a gamble.