It's Time to 'Unfriend' Facebook From Your Portfolio

BALTIMORE ( Stockpickr) -- It's time to "unfriend" Facebook ( FB) from your portfolio.

When the social network announced its IPO, I cringed. Not because the company shouldn't be publicly traded but because of the sheer number of buyers who wanted to buy the stock because "it's Facebook." Things aren't looking much better now.

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The fact is, Facebook doesn't deserve the lofty valuation that's been hoisted on shares in the last few months (even if they've made it a predictable trade), and investors who get caught holding the bag aren't going to be happy.

If you're still agonizing over whether to hit the "unfriend" button on Facebook's profile page, read on.

It's No Google

The biggest reason to unfriend Facebook is its price. The stock is expensive right now, plain and simple.

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A lot of that has to do with its model. When Facebook first started trading last May, the comparisons with Google ( GOOG) were unavoidable. But Facebook is no Google, even if the reasons why are a little more nuanced than many investors care to notice. Google makes the lion's share of its money though ads -- users searching for coffee mugs, for instance, get sponsored results proffering coffee mugs. The fact that Google's paid business aligns users with their reason for being on the site is crucial; without that direct sales path, the sites value is greatly diminished.

Like Google, Facebook earns most of its money through ads. But the difference is that to generate clicks on those ads, Facebook has to distract users from their reason for being on the site (connecting with friends and stalking acquaintances) and convince them to click an ad instead. The fact that Facebook has to distract its users from their purpose for being on the site makes it inherently less valuable than Google.

If you look at the other social media success stories in the last few years, it's the exact same formula. LinkedIn ( LNKD) is one of the best examples. That firm earns most of its money through premium memberships and fees for job postings. In other words, its main revenue model is directly in line with users' reasons for being on the site: hiring or getting hired.

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And while I'd argue that LinkedIn is overpriced in its own right, at least the model is there -- and so is the earnings growth.

Another issue comes in the performance metrics used by advertisers. While Google's software allows for some very precise cost/benefit tracking when using its AdWords pay per click service, many of Facebook's benefits are a little less tangible. How much is a "like" worth, for instance?

Until companies are better able to quantify the return on investment on their Facebook spending, the social network is going to be the first cost that gets cut when the economy hits a hiccup. We've already seen that last year in incremental declines in advertising spending on the site.

It's Expensive

I said that Facebook was expensive, and it is. At nearly $28 right now, the firm has a market capitalization of $66 billion, and a price-to-earnings ratio that's off the charts. Even if we throw out the most recent year's barely-there profit of 1 cent per share and use FB's best year of profits in 2011 to calculate its earnings multiple, the firm still trades for around 100 times earnings.

For comparison's sake, Google traded with a P/E of 77 back in late 2004, just a few months after its IPO. That means that shares of Facebook cost about 30% more than Google did when it was at the same stage post-IPO, when we've already established that Facebook should be trading for a discounted multiple compared to cash cow Google.

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Other valuation metrics spit out similar results. This stock isn't a bargain after falling 30% from its post-offering highs. Instead, it's still quite expensive.

Technical Factors Don't Look Promising

From a technical standpoint, Facebook looks "toppy" right now.

While shares have been rebounding well from a deeply oversold condition back in the Fall, they're losing a lot of their luster now. So even ignoring the fundamental flaws in this stock, traders should be thinking about an exit strategy for Facebook in March.

Facebook is in the early stages of forming a head and shoulders top, a price pattern that's formed by two swing highs separated by a bigger high. The head and shoulders indicates exhaustion among buyers, and after the run that Facebook has had in the last few months, those buyers have good reason to be worn out. From a sentiment standpoint, I doubt that many of them are high conviction buyers to begin with.

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A move below the neckline, currently just above $26, is the immediate-term sell signal for this stock. Momentum, measured by 14-day RSI, has been trending lower too, adding some bearish confirmation to this trade. Add in the fact that Facebook has been extremely obedient to technical factors since it started trading, and this becomes price action worth heeding in March.

There's Value -- Somewhere

I don't hate Facebook. In fact, I wish the company well. And investors should be aware that despite the problems with shares today, there's still considerable value in this company. Just not $27 worth.

Facebook currently has around 900 million monthly active users (depending on what qualifies a user as "active"), and that certainly has value. Even if it's clear that those users aren't as valuable as users of Google's paid search product, they're still worth a lot. So is the mountain of personal information that Facebook has on each one of them.

Targeted marketing data is extremely valuable, and if Facebook can find a better way to walk the line between befriending advertisers and maintaining customers' privacy concerns, there is a huge opportunity.

Online gaming through Zynga ( ZNGA) currently makes up around 15% of Facebook's sales. That revenue stream is exactly the kind of business that FB should be pursuing -- it lines up the firm's sales with what users are actually trying to do on the site. The more money Facebook can earn by helping users get what they want (instead of distracting them), the more valuable each user becomes.

Another obvious piece of value is cash. Facebook has almost $10 billion of it, making up around $4 per share of reduced risk. While that certainly helps to trim back the lofty price-to-earnings ratio (a cash-adjusted P/E is a more meaningful measure, anyway), the firm is still trading for a hefty growth premium to where Google was during the same period.

The long and short of it is that Facebook needs to pursue new products if it wants to justify the sort of earnings multiple that it's currently trading for. As it stands now, the stock is woefully overvalued. Worse, the technical factors at work in Facebook point to a near-term change in trend to the downside.

If you don't "unfriend" Facebook from your portfolio in 2013, you might end up wishing you had.

-- Written by Jonas Elmerraji in Baltimore.


Follow Stockpickr on Twitter and become a fan on Facebook.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to
TheStreet . Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily , and on Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

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