Is Facebook’s record IPO a good investment?

Following an initial surge to more than $42 per share, Facebook's stock closed right around where it started, at $38, in its first day of trading. (Credit: Facebook Inc.)

[The following is a transcript of a Money Talks podcast featuring Morningstar analyst James Krapfel, posted May 17. Quotes from Krapfel in italics.]

With social media giant Facebook Inc. going public at last, investors can start buying and selling shares in the company. But some are wondering if the buzz around the IPO is too great, pushing Facebook’s price too high.

James Krapfel is an IPO analyst with Morningstar in Chicago. He thinks shares of Facebook could pop immediately into the $50 range, with people excited to buy a piece of a website they regularly use.

“There’s lots of excitement around the Facebook IPO. I think a lot of retail investors just want to get in because they think it’s a growing business, they like the product and they are very unaware of the company valuation.”

In other words?is the stock price reasonable compared with Facebook’s anticipated earnings?

“At the high end of the offering range of $38 the company would trade for 105 times our 2012 earnings estimate. So a very, very high multiple that requires near-flawless execution in order to grow into that multiple.”

By comparison, the overall stock market is currently valued at about 15 times earnings.

Facebook is, at least, turning a profit, something that many tech companies like Pandora or Zynga did not do at the time of their recent IPOs.

“For those we tend to look at it from a price-to-sales basis. Most of those have come in a range of five to 10 times forward sales. Facebook at $38 would trade for 20 times our 2012 revenue number. So it’s a pretty significant premium to other recent technology IPOs.”

Facebook generates a large chunk of this revenue through advertising, so the company’s ability to attract advertisers will continue to be a focal point for investors.

“We’ve seen that actually this week with General Motors announcing that they’re going to eliminate their advertising spend on Facebook. It was only $10 million to begin with so it’s not going to be a material impact to Facebook going forward on its own, but I think it’s a sign that advertisers aren’t realizing a strong return on their advertising budget on Facebook.”

Given some of these concerns about Facebook’s ability to grow its advertising revenue base and the tremendous hype its IPO has generated Krapfel thinks investors should probably be wary.

“Our fair value on the stock is $32, so we think the company is already somewhat overvalued in the offering range.”

If the price shoots up on the first day as Krapfel expects, the company could end up even more overvalued. Bottom line: he recommends not chasing the stock skyward.

 

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