Facebook is Overpriced

The earnings season is all set to kick off with Alcoa Inc (AA) reporting its Q3 report next Monday. With so many Wall Street darlings soon to follow, I think investors should be prepared for the earnings season.

Facebook Inc (FB), which has been a great stock for investors over the last few years, is expected to report its earnings in the first week of November. While I expect Facebook to beat estimates of earnings and revenue, owing to its highly effective and cheap digital advertising platform, I don’t think investors should buy the stock at these levels.

The valuation just doesn't make sense

Facebook has consistently inched towards new 52-week highs and is current trading over $128.
The stock has been hovering near its 52-week highs for quite some time, and I don’t think it will be able to move past those levels even if it delivers another great quarter.

Facebook’s market capitalization currently stands at over $368 billion.
Facebook is Overpriced
Image by / pixabay.com
For a firm so big, you’d expect Facebook to be trading at a reasonable value. Given the size of the company, it will be really difficult for Facebook to justify its current valuation, let alone grow any further.

Despite the huge market cap, Facebook is still trading as a growth stock given investors expect its strong growth to continue for a long time. While Facebook may continue growing at rapid rates for a few more quarters, I think the current stock price has already baked in the foreseeable tailwinds.

Again, it's not that I think Facebook will stop growing, but that its current valuation already accounts for the growth, leaving little upside for current investors.

At a trailing P/E of 61 times, Facebook is trading at the valuation of a high growth stock, which doesn’t make sense as a $368 billion firm can hardly continue growing rapid speed.

For the quarter, analysts expect Facebook’s revenue to jump 53% year-over-year to $6.9 billion, which would be very impressive. However, given the stock’s valuation, even a small miss can send the stock crashing. Hence, I don’t think buying Facebook at these levels makes sense.

Some reward, but too much risk

Although I expect Facebook to report another blowout quarter, I can’t see the stock moving much higher from current levels. The risk-reward ratio is unfavorable as most of the tailwinds are currently priced in the stock.

Moreover, given Facebook’s valuation, investors are expecting a lot from Facebook for the quarter, and a small miss on revenue or earnings can send the stock crashing. Investors should stay away from the stock or even consider buying put options heading into the earnings report.
Published on Oct 11, 2016
By Ayush Singh

Copyrighted 2020. Content published with author's permission.

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