Skip to main content

NEW YORK (TheStreet) -- The highly anticipated IPO of social-networking giant Facebook is drawing more than its share of intrigue and controversy, two words that have become appropriate descriptions whenever the so-called valuation debate surfaces.

On the one hand, it intrigues many investors who are on the edge of their seats waiting to see how the biggest crave in the entire world (pardon the hyperbole) now performs as public company. Then there is a faction of Wall Street "traditionalists" who raise their eyebrows at the company's perceived over-valuation and pull out their calculators at a moment's notice to prove it.

When discussing Facebook's valuation, the names that often come up are




and, to a lesser extent,


. But the difference is that those companies enjoy sound businesses. The popularity of Apple cannot be overstated -- for that matter; neither can its

exceptional and consistent execution

. Yet while Apple trades at a high dollar price of $610, the stock remains relatively cheap at a price-to-earnings ratio of 17. So the question is, with Apple being the largest company in the world and making tons of money, should Facebook be valued at a comparable price without having fully developed the business to support it?

TheStreet Recommends

Google also is a high-priced stock. It should be rated "buy" at any level because, as with Apple, it makes a considerable amount of money and is arguably one of only a handful of companies that can support its valuation and growth expectations regardless of the market. For that matter, when one considers its true potential and the fact that it grew over the past three years under significant market and corporate pressures, it proves just what a sound business it has. Yet, the company trades at a P/E of (only) 18. So, again, should Facebook be considered worthy of Google's valuation?

Maybe Facebook should be judged more closely with Amazon, a dominant power in its own right. For those who are waiting for Amazon to falter or drop down to "more realistic" valuations, you are going to be disappointed. Not only does the company continue to show that it has the ability to execute, but it is one of the best at adapting and evolving into untapped growth markets. Its enormous P/E has always offended a lot of traditionalists, but, remarkably, the company has always performed in a manner that suggests Wall Street is right for having applied a multiple that is almost eight times that of both Apple and Google. (Let that marinate for a while.) So is that where Facebook should trade?

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





Bottom line

There 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.