The researchers found that the revenue of the average company going public between 1996 and 2010 grew by 212% over the five years after its IPO.
Assuming that its five-year return is equal to the stock market’s long-term average return of 11% annualized, Facebook shares currently would need to be trading at just $13.80.
I'm as bearish as anybody on FB but this seems like extremely lazy analysis. FB may be many things but average is certainly not one of them.
FB may be many things but average is certainly not one of them.
Several of the other comments you have received relate to this idea, so please allow me to ask a specific question (directed both to you and to onlookers). What is not average about Facebook? For some commenting here, the specific question I have is what is above average about Facebook, related to its revenue, to suggest it will overperform the average of historic experience of companies that have IPOed? As an investor, interested in a non-lazy analysis, what should I look for to decide whether or not Facebook is a good investment at the current price of its stock? I note that you wrote,
I'm as bearish as anybody on FB but this seems like extremely lazy analysis.
so I'm not specifically asking you for a rationale for buying Facebook. Other comments at this comment level or below imply that there may be a rationale (perhaps unconvincing to you, but perhaps convincing to some onlooker) for buying Facebook's stock at today's price. What rationale is that? If I had some extra money, would I be well advised to invest it in Facebook stock? Why or why not?
I'd appreciate hearing from anyone who has an analysis that goes deeper than the news headlines of the last week since the Facebook IPO. Thanks.
Bearish == skeptical. I don't intend to buy FB and I think it's overvalued.
But I say that because I think FB's style of social networking is a fad, not because I believe crude aggregate statistics of internet companies in general tell us something useful in FB's case.
Social networking is not a fad. If anything it's becoming an underlying utility of the internet much like email, instant messaging and search. Any technology that's so core to the internet starts out as a standalone application (hotmail, AIM, Google) and becomes an underlying layer.
Facebook's advantage? They have a virtual monopoly on this utility. Not only that, switching costs are high (unlike email and search).
Look at the kind of growth apps gets from integrating with Facebook (Instagram, Viddy, Spotify). All social apps going forward will only reinforce their position by integrating with them.
Well, the analytical question here is: what is the appropriate sample for comparison?
The article uses US IPOs 1996-2010 as the initial sample. I'd like to know how sensitive this is to expanding or narrowing that range. How does that average change if you adjust the range? (The academic article may have some note of this.)
Then, the article makes comparison to Google's current price-to-sales ratio as a benchmark (5.51-1). The analytic justification is nothing more than "[s]ince Facebook FB -0.64% is most often compared to Google GOOG -0.66%..."
Some questions I'd ask about this:
- What did Google's P/S ratio look like at IPO, and what was its growth?
- What does Facebook's P/S ratio look like compared a broader sample of tech companies' P/S ratios? Or including non-tech companies?
- Why not use price-to-earnings ratio? (I'm not a finance guy, but the subtle difference in wording here gives me pause to at least investigate the question.)
So what you're hearing me say is: we need sensitivity analysis. The assumed benchmarks appear arbitrary enough that we have to see how the results change when you adjust the inputs.
Lastly, there's the age-old fundamentals versus intangibles question: investors make their decisions based on both. The fundamental analysis (of earnings, etc., like the article does) is not deterministic: it just gives you context. Intangibles (faith in management, broader understanding of how the market will shift and affect the firm's competitive position) matter, too. They're just, well, intangible.
But also included under the umbrella of intangibles is how investor sentiment toward the company may change. If people think FB is going to make some huge announcements in the next year that will send the share price skyrocketing for a short (but not sustainable) high watermark, then that potential short-term return is worth buying.
[Edit 5/25 6:57a PT - changed range from 96-00 to 96-10 based on correction. Thanks!]
You don't want to use price to earnings for a company in a growth phase like this. The reason is that they are likely spending their revenue to grow the business (in the simplest example, buying more servers and staffing up).
I think what makes Facebook above average is that at IPO they are looking better than Google did at IPO. I think we can all agree Google is above average.
1) Current P/E is 74 (Google IPOed at 132 and was proven to be undervalued).
2) Facebook has higher revenues than Google did at IPO.
3) Facebook has more users, and more engaged users than Google did at IPO (though there is some question as to whether or not FB can continue to grow users).
Yes, they have to figure out the "facebook way" of delivering ads, but if they do...
Google IPOed into a growing market. It is not clear how FB's market or ARPU will grow from here.
They left negative money on the table at the table at the IPO. Good for them, and probably good for their long-term prospects (big buffer), but from a retail investor perspective, the business has a lot of catching up to do to meet the market.
I actually agree with the $10-15 conclusion right now, but the business has a chance to make up some of that gap before the share price goes there. Probably.
The main argument is that Facebook has created a platform that reaches nearly 15% of the entire planet. Nothing like this has ever happened this fast. Coke and other consumer brands may have similar or even larger markets, but it took them many, many years to get there.
A. You're saying things people also say when we're in a bubble, so we're in a bubble
B. I'm saying things people also say when we're not in a bubble
B. You, on the other hand, are saying the exact things people say when we're not in a bubble
A. I'm saying things that those that are right also say when we are in a bubble
B. Well, I'm saying things that those that are right also say when we "are not" in a bubble.
It's all standard talk, both your comment and what you're responding to and it all gets said both inside and outside of bubbles. What 'is being said' is never an argument. Everything is always 'being said'.
You would have said the same thing about Google and Amazon last time around. For some reason, they were different. Don't make predictions if you don't have an outstanding track record to back them up. Otherwise, nobody has any reason to believe you.
Yes and no... considering FB's incredibly massive eyes on page, today, which might not last... they've been pretty bad about monetizing and they've had about 6 years of knowing they were huge to do it. That's not a great track record (as far as making big returns)
It would be interesting to note what the standard deviation is on those figures. My guess is it's quite high, which does give Facebook a bit of breathing room.
Reading Peter Thiel's lecture notes and I think it is the sixth one that goes into great detail about the returns of new companies following a power law. Hence, the average is mindbendingly irrelevant.
I am certainly not buying into facebook, but not due to this analysis.
if it is a power law in the sense that a few companies return a lot, whilst most return a little, how does that make the mean irrelevant?
the mean of a power law of this form is more skewed by the few companies returning a lot than it is by the majority. assuming that more than 50% of the companies return a little, the median would be irrelevant, but the mean is very sensitive to outliers.
Consider four companies' returns: [1, 1, 1, 100]. The median, 1, is a reasonable predictor for the next company's return. The mean, 25, doesn't seem like a likely outcome.
there is not a normative way to discriminate between those two predictions.
it comes down to what kind of loss you incur for making an incorrect prediction. for mean, it's a squared loss (which penalizes you for being wrong in the tails more heavily) but for a median it's the absolute loss.
the argument being made was that fb is an outlier and (as I read it) the mean didn't reflect it, so the maths was "lazy" as it didn't take that into account. actually the mean does take these outliers into account (since it's corresponding loss function penalizes you harshly for being wrong in the tails) and so is probably not too unreasonable at predicting on outlier companies (certainly better than the median).
That's actually a great point. Even after reading those notes I still wouldn't have thought of applying the power law to my thinking about Facebook (I don't think Facebook will prove anything special long term but it's always useful to be critical in your thinking and consider multiple points of view).
As an aside, those notes are an incredible way of thinking about the world differently. I've gotten a lot out of it.
"New companies" versus "companies that go IPO" are completely different categories.
It's an obvious point when you think about it. This is survivorship bias: many new companies fail (with a return of ~zero) before becoming a part of the IPO sample.
> FB may be many things but average is certainly not one of them.
Do you mean the assumption of 212% growth over 5 years is lowish? If so, I agree.
As for the average return: the author is fixing a price at T+5years, so if you assume a higher-than-average expected return for Facebook, then its current stock price should be even lower.
Also note that even as a back-of-envelope estimate, his analysis is flawed because the 212% figure was calculated by comparing revenues adjusted for inflation, while the 11% figure is for non-adjusted total return. The corresponding real (inflation-adjusted) average return is 7%:
I'm not even going into how they change official statistics arbitrarily on a particular time period, but the article itself says that "Dividends are excluded, so the chart only shows capital gains. The dividend yield of the S&P is running near 2%."
So, 1.9% above inflation plus 2% dividend yield, plus 2.3% current CPI, plus 2.7% "shadow CPI" (the number is from that article you posted) you get a 9% return. That means that facebook should be worth more, not less (since you are discounting at a lower rate).
FB is a much larger company than the average IPO. Larger companies often grow slower as they dominate their markets. With 900 million users, it would seem that the developed countries are fairly saturated and won't see much growth in the user base.
I would be interested to see some projections for FB costs over the next five years. They no longer have the lure of pre-IPO equity to attract new employees. They might have to pay higher salaries instead. Many insiders will be cashing out in the coming months and moving on, so I would guess that FB salary costs are going to climb significantly.
900 million users are not their customers, they are the product. I'm sure that there are lots of people and companies that haven't been advertising themselves on facebook so far -- I'm not suggesting they should, it's just the market isn't really saturated.
Agreed. I read this and said "You are looking back to 1996? Seriously?" Now I am sure that the market will figure out what to do with the company but I sure as heck don't see these guys shorting a few hundred million shares.
But there is a lot of challenges in wrapping your head around the economics here as well. This is why a lot of people don't understand Google's profitability either.
The 1996 to 2000 period was remarkable as the dot-com IPO crazy period. It's the closest, and most optimistic investment environment to what we are seeing today, thus makes a good comparison for making an optimistic valuation model for Facebook.
Assuming that its five-year return is equal to the stock market’s long-term average return of 11% annualized, Facebook shares currently would need to be trading at just $13.80.
I'm as bearish as anybody on FB but this seems like extremely lazy analysis. FB may be many things but average is certainly not one of them.