There is no denying that Facebook has become an incredible phenomenon, one that is proud to report almost 1 billion in active monthly users. That is almost 15% of the world's population, all interconnected with Facebook. The company provides a potential consumer base that is unmatched in the world today. From that view, its potential to offer immediate returns to businesses in the form of targeted advertising is enormous. But does that make it worth $100 billion? That is what Wall Street thinks. But I believe investors are quick to confuse a great idea with a great business, two entirely separate terms.
The company's IPO and pronounced valuation started to intrigue me more when I heard about slowing revenue. Facebook said it earned over $1 billion during the first quarter while also reporting a 12% decline in net income from a year earlier. All of which was attributed to an increase in spending, which is not a huge concern because it costs money to grow. In fact, that tends to be the norm in the tech sector.
However, what puzzles me is the fact that Wall Street is quick to apply a $100 billion valuation on a company that has yet to prove that it has a sound business. Apple sells products, Google is dominant in ads, and Amazon leads in e-commerce and sells a host of services including streaming movies. What does Facebook sell? How much is social networking worth? Should investors base its valuation more closely with LinkedIn or Groupon?
Bottom lineThere is no doubt that Facebook will be successful, but I am not ready to accept that the stock will trade at about 30 times sales and 100 times earnings. The question that investors have a hard time answering is: Do stocks always reflect a company's underlying value? This is where investors often make the mistake of confusing "price" with "value." The result is often seen in the assumptions and expectations. But as logic continues to prevail, there is no scenario that I can envision in which Facebook, as great as it is, justifies the projected valuation. At least until the company shows that it can execute. At the time of publication, the author was long AAPL and held no positions in any of the stocks mentioned, although holdings may change at any time.