Facebook Valuation Problem’s Effect On Your 401(k)

Facebook experienced a profit decline and a revenue decline. See the Wall Street Journal article “Facebook Growth Slows as IPO Nears”. The past six quarters have seen profit decline slightly. For a company that is very young this is a huge part of its history during which profits have shrunk. Profits of $800 million annually using a PE ratio of 15 imply a valuation of $12 billion, yet the company’s shares may trade in the market at $100 billion, which would be a PE ratio of 125. I’m sorry, but being a cool, hip, happening tech company's stock does not excuse a company from adhering to traditional metrics such as PE ratios. OK, fine the company may grow a lot for a decade, but only a decade. Maybe for a future growth factor obe could double the conventional value derived from a 15 PE ratio and then you get a $24 billion valuation, not $100 billion. Assume growth is 8% a year over a decade that would double the value of a 15 PE ratio. Usually after a decade the best and brightest star tech companies become has-beens with mediocre growth. But what if profit actually continues to decline? Then it will be a repeat of the dotcom year 2000 bubble where companies were valued by eyeballs (page views by people who paid nothing) instead of profits.

My reason for criticizing Facebook is to wake people up to the risk of another dotcom bubble crash, which would then lead to a rout in the old tech part of the stock market. I certainly think the company is a great company but investors should follow a Warren Buffett like attitude of avoiding overpaying for stocks, which means avoiding bubble tech companies. I have relatedly seen in 25 years of working in Silicon Valley tech stocks that were a great miracle for a few years and then they flew too high and fell down to earth. The one certainty of Silicon Valley is that change occurs frequently and ends up dislodging the incumbent companies, so I would be careful not to assume a perpetually high rate of growth for any tech stock.

   I wrote an article “Will tech crash lead to stock market rout?” and “Will tech bubble 2.0 create a stock crash?”

Investors should seek independent financial advice.

About the author

Don Martin, CFP®

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