Nothing is more painful in investing than to invest in a company that does well but in the end, the investment turns out to be a dud. It happens all the time in business because many investors cannot distinguish between a good business and a good investment. For those getting excited about the upcoming Facebook initial public offering (IPO), consider yourself warned.
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By many accounts, Facebook is an amazing company. Spawned from the simple idea of developing a way for college students to interact, the company has become a global phenomenon. It has roughly 901 million active monthly users and around 13% of the world's population is connected via Facebook, and that number is climbing rapidly. Never has a company provided such an efficient way to reach an audience as global and as diverse as Facebook has done in a relatively short period of time. It's no surprise why businesses from all over are eager to team up with Facebook; the company provides a potential consumer base that is unmatched in the world today. Naturally, there is immense value in what Facebook has to offer to company's wanting to advertise, promote or sell a product or service. Undoubtedly, that value will grow over time.
SEE: Evaluating The Facebook IPO
Mr. Market has decided to value Facebook at about $100 billion based on the IPO set to occur next month. According to the company's most recent quarterly filing, Facebook revealed that it had earned over $1 billion in revenue during the first quarter. That was a decline from the year ago period. Net income of $205 million was also down 12% from the year ago quarter. The company cited a significant increase in spending as the result of the declining numbers. Aggressive spending by tech companies is nothing new. Google (Nasdaq:GOOG) has been increasing spending in order to remain at the forefront. In its heyday, Microsoft (Nasdaq:MSFT) spent billions in order to ensure its software dominated the market.
SEE: Did Facebook Overpay For Instagram?
The Bottom Line
The decline from Facebook is not the issue; the enormous valuation is. At $100 billion, Facebook will be valued at approximately 25 times sales and 100 times earnings if one were to analyze the first quarter results. Facebook will surely grow its sales and profit going forward but at what rate and for how long is uncertain. What's also uncertain is how likely its users and advertisers will continue to fuel that growth. Unlike Apple (Nasdaq:AAPL), the world's most valuable company which happens to trade around 4 times sales and 16 time's earnings, Facebook doesn't sell product. It offers a social network, a valuable one but not so at $100 billion. Groupon (Nasdaq:GRPN), a recent IPO that was hailed as the next big tech home run, has been a bust. Shares now trade for under $12, nearly half of the company's IPO offer price.
Facebook's real wealth has already been made. There may be a little left, but it's likely a speculative bet. To new investors, Facebook will likely have few friends in the end.
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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.