When it comes to judging a company's worth, value investors like Warren Buffett look at intrinsic value. By that measure, Facebook's shares are worth less than $10. Thomson Reuters analyst Jharonne Martis breaks down the math in this episode of Investing 201. (May 23, 2012)
Reuters correspondent Fred Katayama interviews Thomson Reuters analyst Jharonne Martins and poses a very interesting question:
"How much is Facebook really worth?"
Here's the full text of that interview:
Fred: Jharonne, you've scowered through Facebook. How much is Facebook really worth?
Jharonne: Well, according to StockLine, it should actually be valued closer to $9.59.
Fred: $9.59. How did you arrive at that value?
Jharonne: Well, the market is assuming that the company will have to grow at 24% per year over the next ten years every year to sustain that stock value ($34.03).
Fred: And that contrasts with the more reasonable 10.8% annual earnings growth over ten years that you calculated to get your $9.59 per share.
Jharonne: Yes.
Fred: Jharonne, what is intrinsic value?
Jharonne: Well, intrinsic value systematically adjusts for optimism bias especially for fast growing companies when you're looking at longterm forecasts.
Fred: How does Facebook's intrinsic value compare with those other high-tech firms?
Jharonne: Well, it is still considered an over-valued stock, especially when you compare it with Apple, and also Google. On the other hand, Amazon is one stock that is considered over-valued.
Fred: Alright, so Amazon and Facebook (are) way over-valued. Why should anyone care about intrinsic value?
Jharonne: That's the stuff Warren Buffet cares about. When he purchased Burlington Northern, he still payed less than the fair market value, so Starcccc knew they were getting a good deal.
Fred: So Jharonne, does this make Facebook the most over-valued content company?
Jharonne: No, it makes it the second most over-valued firm right after Salesforce.com.
Fred: So No 2 at $9.59 intrinsic value. Thanks, Jharonne. That was Jharonne Martis of Thomson Reuters. I'm Fred Katayama for New Ideas for Investing 201.
COMMENTARY: In finance textbooks, intrinsic value refers to the value of a security (stock, bond, treasury bill) which is intrinsic (attached to) or contained in the security itself. It is also frequently called fundamental value. It is ordinarily calculated by summing the future income generated by the asset, and discounting it to the present value. Simply put, it is the actual value of a security as opposed to the market or book value.
In valuing stocks, security analysts may use fundamental analysis — as opposed to technical analysis — to estimate the intrinsic value of a company. Here the "intrinsic" characteristic considered is the expected cash flow produced by the company in question. Intrinsic value is therefore defined to be the present value of all expected future net cash flows to the company; it is calculated via discounted cash flow valuation.
An alternative, though related approach, is to view intrinsic value as the value of a business' ongoing operations, as opposed to its accounting based book value (assets less liabilities), or break-up value. Warren Buffet is known for his ability to calculate the intrinsic value of a business, and then buy that business when its price is at a discount to its intrinsic value.
In the case of Facebook, using fundamental analysis, its intrinsic value of $9.59 was calculated by estimating its future net cash flows over a ten-year period, then discounting them by 10% to the yield present value of those cash flows. When you divide that figure by the number of shares outstanding 2.147 billion shares, this yields the $9.59 intrinsic value per share.
By now, most stock investors know that Facebook shares ended their first day of trading at $34.03 per share. According ot Jharonne Martis, Facebook's intrinsic value is only $9.59 per share. That's a whopping difference of $24.44 ($34.03 minus $9.59). This begs another very interesting question:
"Is investor optimism bias worth $24.44?"
If you calculate Facebook's market value-to-intrinsic value ratio (MV-to-IV) ratio you get a ridiculous 3.96 (38.03/9.59) or roughly 4 times the intrinsic value. That's just too much optimism. Keep in mind that Facebook amended its SEC S-1 registration statement eight times. The last time it was to warn investors of the risk the company faced in monetizing mobile. Furthermore, there were over fifty risk factors listed in the registration statement, an unusually high number for a company that has been around seven years (2005). It appears that investors gave Facebook a pass on the risk factors and overlooked its failure in monetizing mobile.
To be totally honest, Facebook's MV-to-IV ratio is over-inflated not solely by investor optimism about the future of Facebook, but a significant amount of investor hype and what is commonly referred to as the "Facebook Halo Effect," or a belief that Facebook is so big and dominates social media so completely, that it cannot possibly do any wrong. By any measure, Facebook's MV-to-IV ratio is downright scary when compared to those of Apple and Google as of May 18, 2012. Only Amazon.com is higher with a MV-to-IV ratio of 6.892.
- Apple - Market Value (530.38) divided by Intrinsic Value (881.40) = 0.602
- Google - Market Value (600.40) divided by Intrinsic Value (680.80) = 0.882
- Amazon - Market Value (213.85) divided by Intrinsic Value (31.03) = 6.892
- Facebook - Market Value (38.03) divided by Intrinsic Value (9.59) = 3.965 (IPO Date)
- Facebook - Market Value (28.19) divided by Intrinsic Value (9.59) = 2.93 (As of 5/30/12)
A MV-to-IV ratio of "1" would mean that the intrinsic value and market value of the stock are the same. As expected, the MV-to-IV ratios of Apple and Google are less than one. Anytime the MV-to-IV ratio exceeds the value of "1" by a considerable amount, you have to seriously question whether that company's stock is over-valued. This appears to be the case for both Amazon and Facebook.
It should be worth mentioning that one of the factors that has inflated Facebook's MV-to-IV ratio is the large number of shares (421 million) floated during the IPO. In Facebook's case, floated shares represent 15% of total outstanding shares (2.147 billion). This makes Facebook shares less scarce compared to LinkedIn and Groupon which had much lower floats during their IPO's. In fact, there are too many Facebook shares in the public domain and fewer investors willing to buy Facebook shares at the market price. This has driven down Facebook's share price from $38.03 at the end of trading on its IPO day of May 18, 2012 to its present $28.19--a decrease of 25.87%. Since the IPO date, Facebook's market capitalization has gone from $104.5 billion to $60.27 billion--a decrease of $44.23 billion in value. No wonder so many investors are pissed off at Facebook and filing lawsuits.
As of Wednesday, May 30, 2012, Facebook's MV-to-IV ratio stands at 2.93. This is still high since it is well above "1" or parity. It is obvious that Facebook shares have a way to go before they reach parity or a more acceptable MV-to-IV ratio. Main Street sets the market value, and it definitely was not $38.03.
Courtesy of an interview of May 22, 2012 by Fred Katayama of Thomson Reuters analyst Jharonne Martis
Chris, Stay away from FB, that's my advice. The company is run by a 27-yr old Harvard dropout, who just happened to get lucky. He's the wrong guy to be running FB. I should be running that company. No more hackathons or free meals. Zuck cashed out to the tune of $1.1 billion. Lucky stiff. When FB's Q2 2012 earnings call comes out, FB will lose half its value overnight. That $9.59 price is not too unrealistic. Write that down somewhere.
Posted by: Tommy | 06/13/2012 at 03:57 PM
What is the future of Facebook share value? Pls give some tips and advice to me......
Posted by: Chris | 06/11/2012 at 10:54 AM