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Buy, Sell or Hold: When to Buy Shares of Facebook

You might have heard….

Facebook Inc. (NYSE: FB) is the most awaited initial public offering (IPO) since Google Inc. (Nasdaq: GOOG).

The recent registration of the company's IPO documents means it won't be long until Facebook shares begin trading freely.

But will Facebook shares make you rich beyond your wildest dreams like mural painter David Choe?

Or would you be better off watching from the sidelines before you buy shares of the social media giant?

The Details behind the Facebook IPO

Here's what I've learned from Facebook's S-1.

Some of the data points buried in the IPO document are eye-opening, to say the least.

Chief among those are Facebook's assertion that 6% to 7% of the entire world population logs in every day. More importantly, they stay logged in for a significant amount of time.

However, what will happen in the future to drive the stock's share price after it's brought to market is buried deeper in the details.

It's these details that make Facebook's IPO a hold if you already own shares, but also a "wait to buy" if you are like most people and want to own them.

In a nutshell, what I've learned is the banks are bringing Facebook to market fully priced.

My opinion is the bankers have gotten greedy and decided to push the valuation numbers above the levels that I believe are sustainable.

The company is being valued at $75 billion – $100 billion dollars at launch. This would make it one of the most valuable companies in the world, yet its actual revenue, let alone profitability, is at a more mundane level.

Currently, Facebook is reporting about $4 billion in revenue and profits of $1 billion.

That means if Facebook prices in at the top of its estimated range ($100 billion), based on current disclosures it would have a 100-to-1 price to earnings (P/E) ratio.

In other words, it's only going to take about 100 years for Facebook to eventually earn what it may price at. Compared to other blockbuster stocks, that's quite rich.

By comparison, Apple Inc. (Nasdaq: AAPL) has $100 billion in cash and a P/E ratio of 11 while Google's P/E is 20.

That's why it's time to "Hold" Facebook (**) or wait to buy it until insiders get a chance to sell their shares and bring the price down to levels common people can realistically afford to purchase.

Key Points on Facebook

Now don't get me wrong. Facebook has a lot of things going for it.

It's grown from a dorm room project seven years ago into a Website with a staggering 6% to 7% of the world's population logging in daily. It's debt-free and its future unleveraged.

This is all good but there are other aspects that need to be discussed when considering Facebook as an investment.

For instance, the growth rates are slowing down.

Facebook had a 44% growth rate in the fourth quarter alone. That sounds good, until you realize that Google at the same time in its development was at a much higher run rate. The company also gets 80% of its revenue from ads.

That being the case, the IPO is fully pricing what Facebook should be worth down the road.

And no matter how you slice and dice the current numbers, I think the current valuation metrics are overheated.

Also of note: The company gets 12% or so of its revenue from gaming sources made available to its users. The relationship with Zynga Inc. (Nasdaq: ZNGA) is a material weakness in the business model in my opinion, as users evaluate their spending patterns over time.

Facebook required game providers to turn over 30% of the revenue generated, starting in 2011. This growth in revenue will slow down significantly as the one year phase-in period expires and growth starts to show consistent results instead of a high-flying ramp to the stars.

Action to Take: "Hold" Facebook. (NYSE: FB) (**).

The impressive growth rate of the Facebook story is going to slow down as the company has to compare itself with other companies on an apples-to-apples basis.

The bankers have priced the estimated valuations at the extreme top of what should be expected. This leaves very little room in the equation for investors to see the type of move up in valuation that investors in Google saw when it came to market in 2004.

The company is being brought to market with a P/E of 75-100, when its real peers are trading in the 11-30 range. The competitors have proven they have a capacity to monetize their business models while Facebook is still in the category of an extremely large user base and very little actual revenue deriving from it.

When Facebook has a P/E ratio below 50, I will most likely change my opinion and consider it a "Buy" on weakness. For now, I consider Facebook to be a wait-and-see investment, with a hold on any shares you have from the IPO.

Social fads are great, until you buy the top in them. Just look at how MySpace, Zynga, and LinkedIn have fared since they came out to play.

It may be years before Facebook is grown-up enough to be considered an investment.

For now it's the biggest social media stock, warts and all. I would wait for Facebook to grow up into an adult investment before I would commit capital to it.

(**) Special Note of Disclosure: Jack Barnes has no interest in Facebook Inc. (NYSE: FB).

About the Writer: Columnist Jack Barnes started his career at Franklin Templeton in 1997. He started out in the company's fund-information department – just as the Asian contagion infected the Asian tiger countries.

Barnes launched his own shop, RIA, in 2003, just as the second Gulf War was breaking out. In early 2006, after logging a one-year return of nearly 83%, Forbes named Barnes the top stock picker in its "Armchair Investors Who Beat the Pros" competition. His two audited hedge funds generated double-digit returns in 2008.

Barnes retired to the beach in the summer of 2009, and continues to write from there. He's now the author of the popular blog, "Confessions of a Macro Contrarian," and his "Buy, Sell or Hold" column appears in Money Morning.

In his BSH column last week, Barnes analyzed Carnival Corp. (NASDAQ: CCL).

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Join the conversation. Click here to jump to comments…

  1. Sam | February 7, 2012

    Thats what i was telling my friend last night..

    $1 profit and $100 worth.. tooooo much expensive..

    I was asking him to buy google shares instead as it can go to 1000 due to FB pricing.


  2. Bob | February 7, 2012

    Mr. Barnes – This is a very good article about Facebook. You point out some things that I haven't seen in other writeups. One statement in particular I found really interesting is how you re-defined the P/E ratio in layman's terms (or for dummies in my…). I never thought about P/E ratios in terms of years. Such as when you suggested that, with a possible $100 billion valuation and $1 billion in profits and therefore having a P/E ratio of 100, it would take about 100 years for Facebook to earn what is may be priced at. That really hits home with the potential rich valuation it may be given. And so, with Apple's P/E around 11 and Google's around 20 does that mean that I can think of it in terms of 11 years for Apple and 20 years for Google to earn what they are priced at? I just never thought about being able to compare P/E ratios in that way. Or maybe I am wrong, showing my ignorance and this is the dumbest comment you have seen from someone – I hope not. Either way, thanks for your time in reading this and for writing the original article. I would think many people found it of interest. Now I have to go back and search for your past articles! – Bob C.

  3. Dan | February 7, 2012

    The P/E is not 100, the value of the company alone can't be used to speculate about P/E. The P stands for price per share, not value of company. The number of shares created and their price still have yet to be determined. Then you must find the earnings per share….not overall earnings. After a VERY rough crunching of some numbers I'd put the P/E closer to 80 than 100 (and it's probably much lower than that). What is in this article is so simplistic that it doesn't even begin to explain things.

    [written by a concerned investing professional!]

  4. Mike S550 | February 8, 2012

    Great Article. Good helpful information. Thank you.

  5. warren | February 22, 2012

    A great article! Lot's of useful info. I know the painter took stock instead of payment for the murals at FB original offices, but how do other people have shares or stock right now?

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