Thursday, February 2, 2012

FB: Friending the Financials

Facebook Inc (FB) sometime in the next few months will go public. (The FB symbol hasn't been approved yet by the Securities and Exchange Commission.)

Like new-born baby, FB has no history, no chart -- nothing that a technical analyst can hang a hat on.

But it does have a financial history, courtesy of the Statement of Registration filed with the SEC.

FB is proposing to issue up to $5 billion in shares split into Class A and Class B. Class A has one vote per share, and Class B has 10 votes. The company used both classes in calculating its earnings per share for 2011.

FB is proposing to issue something like 1.9 billion shares of both classes.

Revenues (sales) for 2011 totaled $3.7 billion, and on that the company had net earnings of $1 billion. Shareholders equity was $4.9 billion.

Revenues and net income have grown like gangbusters beginning in 2009, as has the customer base. The numbers show FB to be what we all knew it was: A tech start-up that took off and is now rocketing toward the heights. Call it Google II. Or Microsoft the Sequel, for those who remember the ancient days.

I use a very simple analysis to understand the fundamentals of stocks. Raw numbers are the books lack context. So I make heavy use of ratios to make the numbers my friends.

I look at return on equity, as a measure of the management's efficiency. How much profit did they produce off of shareholders' portion in the company?

FB in 2011 had a return on equity of 20.4%. Anything from 20% up is potentially a growth stock in my book.

I look at the debt/equity. If a company has had to go deeply in debt over the long-term to achieve its results, then it's not really earning entirely from its own operations. Long-term debt can be a good thing if it increasing earning capacity. But whether good or bad for business, high debt levels mean impaired capacity to meet downturns and other emergencies.

FB has no long-term debt. Zero. So the combination of no debt and a high return on equity means FB is growth stock, the way I look at companies.

The third item I look at is the price/sales ratio, which tells me how much it costs to buy $1 in sales (revenues) .

Since we have no price for FB -- the brokerages underwriting the initial public offering will set an opening price shortly before trading begins. So to get a price/sales ratio, we need to work backward, estimating a ratio and see what price it would take to produce it.

Google (GOOG) is probably a good comparison with FB. True, GOOG is well beyond its IPO back in August 2004. But it is one of the few companies around that matches FB for reach and -- how to phrase it? -- entanglement in people's daily lives.

GOOG's opening price was $100 a share -- it closed Thursday at $585.11. It's present price/sales ratio is 4.98, meaning the price is 4.98 times sales per share.

Applying that FB's revenue per share -- $1.98 -- I get an imputed price of $9.85 per share. That seems awfully low, so lets try something else. GOOG's price/earnings ratio is 10.15, so aplying that to FB's earnings per share, and we get an estimated price of $10.15.

Well, $10 is clearly a ridiculously low price with nothing to do with what will actually happen when trading opens on FB. Personally, I suspect it will much more.

But there is something to think about here: If FB is priced above $10.15, then it is being valued at a higher price than GOOG commands today.

Try again: Apple's (AAPL) price/sales is 3.33, and its price/earnings is 12.99 -- both less than GOOG's. So anything above $10.15 a share for FB would be more expensive compared to sales and earnings than AAPL's current price of $455.12.

Long awaited IPOs have a tendency to run amok in irrational exuberance, and then to fall. GOOG was an exception to that observation. FB might be as well.

But, remember Red Hat (RHT)? It rocketed up for five months after opening at $23, reaching at its peak $151. Then it fell, and 10 months later was selling for $2.40. It now goes for $47 a share. That also might be FB's future.

Without a history on the chart, with only the fundamentals and the pricing as my guide, there's no way to tell which track FB will follow. I intend to wait before opening any position on FB's stock.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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