A Splash of Cold Water for Facebook Investors

May 29, 2012 in Business, Featured News, Top News, U.S. News

A Splash Of Cold Water For Facebook InvestorsFacebook’s IPO fueled a surge of excitement, but the numbers point to more measured expectations for stock investment gains ahead. Price per share has declined since the IPO and earnings may prove disappointing. The IPO sold for $38 per share and Facebook had expected to generate market capitalization of about $86 billion. Currently Facebook is trading at $32.91 a share and is valued at $82.2 billion. Factor in Facebook’s 2011 earnings of $1 billion. With 2.5 billion outstanding shares, that yields an estimated price-to-earnings ratio (P/E)† of 82.28. Compare that to Google’s 17.93 (GOOG) or Microsoft’s 10.64 (MSFT). Can Facebook outperform the giants of the information field and deliver on its promise to investors?

Shawn Tully, Fortune senior editor, predicted what would happen prior to the actual IPO. What did he think would be required for IPO buyers to expect reasonable returns from their investments? He opined that in order for a stock buyer ultimately to realize 10% annual returns over a classic 7-year holding time, Facebook would have to raise its price per share by 95% net of dividends by 2019. Factor in a conservative 7% issuance of employee stock shares (1% annually) on top of that, and we’re looking at expectations of over $180 million in market cap by 2019. How much shine and luster will the “phenomenon called Facebook” enjoy in seven years?

Tully’s math reveals that to deliver on its expectations, Facebook would need earnings of nearly $9 billion, and a compound annual growth rate of 37%. That’s three times the average return on equity for the largest U.S. companies. Tully developed the numbers further on into 2023, with slightly moderated assumptions, but the point is clear enough just from these facts. Facebook would have to figure on a P/E ratio of 20 and exceed that of even Microsoft’s $69.9 billion revenue for these numbers to play out.

Today’s numbers and Fortune’s analyses spell a much more circumscribed range of performance possibilities than frothy media coverage acknowledges. Placing the above forecasts in context, Facebook would be worth more than Microsoft is today. Only nine Fortune 500 companies earned $15 billion or more in 2011. Between now and 2023, Facebook would have to capture close to 8% of the world’s ad market to live up to the simple expectations assumed here.

The Facebook of today needs to become the Facebook capable of living up to its target projections. Once the IPO becomes yesterday’s news, it comes down to execution. Markets and models relevant to the social networking economy may change faster than a large and public company can commandeer viz-a-viz ever-emerging new competition. Time will tell: Can rosy figures be turned into fertile green?

† P/E = Stock Price / EPS (Earnings Per Share). EPS = Net Revenues /  # Outstanding Shares. Higher numbers indicate a lower return

Arthur Burditt served as Research Analyst and Director of Special Studies for the Tax Foundation, Inc., a non-profit, non-partisan fiscal research organization based in Washington, D.C., during the Reagan years. He received his B.A. in Public and International Affairs from George Washington University’s Elliott School in 1975, and a Master in Public Affairs (MPA) from Princeton University’s Woodrow Wilson School in 1977.