MENU

Facebook at $40: Wasn’t this an overvalued IPO dud?

Remember all that hype about Facebook (NASDAQ: FB)  stock when the social network went public at US$38? The valuation was astronomical, critics complained. As the shares continued to fall as low as US$17.55 in the coming months, the bears were emboldened. It became commonplace to liken the Facebook euphoria to the dot-com bubble.

But today it’s a different story. The stock is back above its IPO price, analysts are excited, and the stock is on a run. What’s changed?

Facebook in the summer of 2012: Can Facebook monetise mobile?

Just about a year ago, Forbes writer Eric Savitz pitched in with some expert-sounding investment advice:

[E]ven at US$20 and change, the stock is no statistical bargain. … The problem is that the stock was so outrageously expensive when it went public that the shares STILL look expensive versus almost any other technology company. … The bottom is out there, but I’m not convinced this is it.

He certainly was right: US$20 wasn’t the bottom for Facebook stock — but it was pretty dang close. The stock now trades at more than a 100% premium to its all-time low of US$17.55.

But let’s give Savitz some credit, as his underlying thesis was based on a legitimate concern. “[W]hat I think we do know is that unless Facebook can do something to improve its growth rate, there seems little obvious reason for it to trade at a gigantic premium to Google,” he explained.

Sure enough, Facebook’s 2012 second-quarter results certainly weren’t indicative of a growth company worthy of its P/E ratio of about 85 at the time. Revenue was up 32% from the year-ago quarter — nice in isolation, but not when valuation was taken into consideration.

Even more, Facebook’s mobile revenue at the time amounted to zero, zip, nada.

In hindsight it seems silly, but investors wondered: If the company makes money from ads on the side of the feed now, how will it ever fit them into a small smartphone display without being obtrusive to the experience?

Of the company’s 955 million monthly active users, or MAUs, 543 million were mobile — and Facebook hadn’t figured out how to monetise them. Uncertainty prevailed.

Facebook today: Mobile domination

Eventually investors’ long-awaited answer came. Facebook could put ads in the feed itself, giving them the same social characteristics a typical status update has.

It worked. Ads in the feed, a redesigned timeline, and improved ad products helped the company enter a new phase of growth. Facebook was executing swiftly.

Today Facebook has undoubtedly proved that not only can it monetise mobile, but also that it can excel in mobile.

In the second quarter of 2013, mobile MAUs were up 51% from the year-ago quarter. More importantly, mobile advertising revenue accounted for a whopping 41% of total revenue. And the company now looks like a growth stock deserving of its lofty P/E, with overall revenue soaring 53% from the year-ago quarter.

The impressive second-quarter results have investors more confident than ever in the company’s future.

Since the results were released, the stock has been soaring.

FB Chart

FB data by YCharts

Facebook tomorrow

The company has certainly proved it can succeed in the modern connected environment. Even more, its strong network effect, bolstered by 699 million daily active users, or DAUs, practically secures the company’s position as the go-to social network for years to come.

But unfortunately, price does matter. At 15.8 times sales, or more than three times Google’s 5.1 price-to-sales ratio — the stock isn’t something I can make a bullish call on right now.

Sure, I’m far from ending my CAPScall on the stock. But if I bought into it at today’s price, it would be a small nibble with expectations for a very volatile ride.

At the same time, the company’s powerful network effect and proven ability to monetize mobile give the company the enduring characteristics I’m searching for — so that “small nibble” sounds pretty tasty right now.

The Australian Financial Review says “good quality Australian shares that have a long history of paying dividends are a real alternative to a term deposit.” Get 3 Stocks for the Great Dividend Boom in our special FREE report. Click here now to find out the names, stock symbols, and full research for our three favourite income ideas, all completely free!

More reading

A version of this article, written by Daniel Sparks, originally appeared on fool.com.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.