The Strong Bear Case for Facebook

There is no doubt that Facebook (FB) is a great company and the company’s management is also very competent. Facebook’s strong growth over the last few years has seen the stock jump over five folds and the stock is now trading near all-time highs.

Growth of Facebook’s advertisement business has led to the strong surge in stock price. Facebook now has over 3 million people advertising with it and as a result, the company has been beating analysts’ estimates with ease. In the last quarter, Facebook reported EPS of $0.77, beating the consensus of $0.62.
On the sales front, Facebook reported a 52% year over year jump in revenue, taking its top-line to $5.38 billion, surpassing the analysts’ estimates by $120 million.

Consistent earnings beat and strong growth indicates that Facebook is a wonderful company. However, after the recent upsurge, it looks like the stock is running way ahead of its fundamentals. After the recent rally, Facebook’s market capitalization stands at almost $340 billion.

Despite the towering market cap, investors have priced Facebook as a growth stock and expect the company to continue reporting double-digit growth for at least a few more years. With a trailing P/E ratio of 72 and a P/S of 17, Facebook is clearly overvalued. Investors have priced in years of growth into Facebook’s current valuation and the company will need to deliver on every front just to grow into its current valuation.

Hence, the upside for Facebook here looks pretty limited and the risk to reward ratio looks very unfavorable. With Facebook trading neat 52-week highs, it will surely face selling pressure from institutional holders in the near term, which is why I think investors should not buy the stock just yet.

While I love Facebook’s business model and its strong growth, I don’t think Facebook will sustain its current valuation for a long period of time. Even if Facebook beats all growth estimates, it will take a lot of time for the company to grow into its current valuation. At 17 times trailing sales and 72 times trailing earnings, Facebook is very expensive. And given its market cap of $340 billion, I think the company will find it very hard to grow into the valuation, let alone move higher.

Hence, I think investors should watch the stock from the sidelines and wait for it to drop before initiating a long position.
Published on Jun 2, 2016
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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