Business

Facebook still poking its way to higher levels

The Sterling Report

Kevin Richards

Sunday, August 31, 2014    

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IT has been just over two years since one of the most anticipated initial public offerings in the post- financial crisis period came to market -- Facebook.

Most analysts were sceptical of Facebook's earning prospects for a variety of reasons. The consumers' swift shift in focus away from desktops and laptops and their new obsession with mobile phones and tablets was one such reason.

Many felt that Facebook's success in generating revenue from online advertising was a result of the utilisation of desktop computers. Analysts remained unsure of how this revenue generation capacity would be replicated on mobile devices.

The stock opened at US$38 and within a few weeks of its listing it was trading at a 50 per cent discount to its list price. This was not helped by the sale of large blocks of shares from early investors such as Peter Theil who sold 16.8 million shares for US$638 million soon after the IPO. This led many investors to question the prospects of Facebook as a going concern.

Theil then went on to sell a further large chunk of his remaining shares at prices hovering around the US$20 mark. Theil, a hedge fund investor and one of the originators of PayPal, had turned his early US$500,000 investment in Facebook into a billion dollar investment.

The stock price remained in the low twenties for quite some time, with many arguing over the company's valuation.

Despite the price declines, Facebook remained consistent in ploughing along with its mobile strategy and the Company has seen a steady rise in its stock price over the last twelve months.

The stock closed trading at US$40.10 at the close of business on August 29, 2013. At the time of writing this article the stock was trading at US$74.87, representing an 87 per cent appreciation in price. This compares with a 22 per cent gain in the benchmark S&P 500 index over the same period. Not bad for a stock that many analysts had written off and for which many investors still question its valuation.

For non-financial industry readers, a price earnings ratio is used to determine the relative value of a stock. As the name suggests, it is comparing the stock's price to its income. Sometimes a higher ratio is typical of a stock that investors expect to see rapid growth or it could mean the Company's earnings are too low to justify the stock's current price.

The reverse in true also; a low ratio could also imply that a stock is undervalued. Average market P/E ratio on the Jamaica Stock Exchange, for example, is approximately seven times earnings while in Europe it is approximately 12 times earnings.

To give you even better context, long-established companies such as Apple, a familiar business model, have had a less impressive twelve months, despite their stock split. Apple trades with a P/E ratio of 16.5 times earnings while Google has a P/E ratio of 29.1 times earnings.

To put the Facebook valuation into context, the average market P/E (Price to earnings ratio) for the S&P 500 index is 19.2 times earnings while Facebook is currently trading at a P/E of 46 times earnings. The Nasdaq 100 has an average P/E ratio of 23.1 times earnings, which is still 50 per cent below the PE ratio of Facebook.

The question now on everyone's lips is "Where goeth the stock's price?" That could be anyone's guess unless you are a gifted seer or your crystal ball just arrived in the mail. It would appear that Facebook's strategy going forward is big on acquisitions and is enroute to achieving "Google-like" dominance, potentially blowing the competition wide out of the water.

Who remembers the Hi5s, Friendsters and MySpaces of the world? Facebook's US$19 billion acquisition of Whatsapp is definitely a good strategy to boost their mobile advertising revenue and to provide them with great insight into consumer habits.

This is a vital asset to achieve a more targeted advertising reach. As usual, it is always best for investors to meet with their financial advisors who will be able to guide them in investment decisions suitable for their risk appetite.

Kevin Richards is Vice President, Sales and Marketing at Sterling Asset Management Ltd. Sterling is a licensed securities dealer and provides investment management and advisory services to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, please e-mail us at: info@sterlingasset.net.jm or visit our website at www.sterling.com.jm. Like our page on Facebook and follow us on Twitter.

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