If profit growth doesn't match P/E, it will be difficult for Wall Street to "like" a lofty price-to-earnings ratio for too long, and might defriend or is it unfriend the stock? We are not too concerned with one hiccup as the year over year quarterly revenue growth was 44%, but still not enough to warrant a triple digit P/E.
With 82% of their revenues coming from advertising, the social site's sales and earnings will be somewhat dependent on the health of the US and global economy. As a rule of thumb, as the economy grows so do ad budgets, and advertising spending slows when the economy retreats.
The good news for social sites, especially Facebook, is that interactive marketers are starting to understand how to maximize targeted personas i.e. Facebook profiles to maximize ROI. The higher return on investment goes, the more dollars they will spend.
Moving on, per the prospectus, Facebook will have 2,138,085,037 class A and B shares outstanding after the initial public offering. Again, using our hypothetical price range, FB will have an initial market cap between 94.7 and 156.2 billion. Using last year's revenue of $3.71 billion, Facebook will trade from 25 to 42 times sales. Both are at a premium to LNKD, which trades at 18.5 times sales.
If Mark Zuckerberg can continue growing revenue at 44% in 2012, the P/S numbers would drop to a range of 17.73 to 29.25. Either way, we don't think Ken Fisher or Warren Buffet will be among shareholders any time soon, unless they scalp the IPO.
Our Take: Facebook (FB) is likely to be a solid trade in its first few public days. Longer-term, iStock would like to see the company's P/E ratio be no more than twice its earnings growth. Minus the stock getting crushed, FB's price-to-sales might take years to get to a comfortable level for value and growth investors.
Additionally, the company must diversify and expand its revenue streams. As it is now, Facebook is essentially a one trick 82% advertising pony. Management has made it clear that they understand this risk and is exploring strategic acquisitions in the mobile, wireless space.
Tell us what you think in the comments section below or reach out to me at Rich at wallsttolls dot com.