Things have been topsy-turvy lately for Facebook and its users. You may have seen Zuckerberg’s face popping up on your news feed lately (Facebook-Inception anyone?!). And while I won’t go into the details on the scandal in this post, if you’re interested in learning more, here is a great summary from Vox.com. The important point is that users are pissed (and rightly so) at this technological behemoth for its lack of data privacy… so pissed that the stock saw an approximately 13% drop over the past few weeks.
This, my friends, is what we call an “event”. Negative news causes the stock price to tumble below its long-term predicted value. I.e. Your favorite clothing brand goes on sale. Of course, not everything that goes on sale is worth owning. After all, 30% off at J.Crew gives me completely different feels than the same sale at Forever21. One garment will last me years, the other a few washes. But alas, which is Facebook? Are we talking a J.Crew or Forever21 kind of sale?
I took Facebook’s stock plunge as an opportunity to value my first company based on the Warren Buffet style of investing, learned from Danielle Town in an excellent book Invested. The following is my own analysis and calculations and are not meant as a recommendation of any sort.
Let’s start, as any good engineer would, with the numbers.
|Category||Avg. Growth/ Year||Median Growth/Year||Morgan’s Commentary|
|Net Income||436%||55%||Year over year growth rates ranged from -95% to 2730%. Because of this wide range, the median (instead of the average) gives a much more realistic picture of FB’s growth.|
|Stock Holder Equity||54%||30%||Year over year growth rates ranged from 23% to 133%.|
|Sales||55%||54%||Year over year growth rates ranged from 37% to 88%.|
|Operating Cash||75%||52%||Year over year growth rates ranged from 4% to 200%.|
|Return on Equity (ROE)||6%||N/A||ROE is net income divided by equity. FB as a slightly lower ROE than I’d like to see (ideal is ~10%), this could be, however, because of the high cash holding FB has. Cash holdings increase the dominator (the equity), while do not do anything to increase the numerator (income). This cash will likely be reinvested back into the company down the road so I’m ok with this number.|
|Return on Invested Capital (ROIC)||7%||N/A||ROIC is net income divided by (equity + debt). Facebook has very little debt so ROE and ROIC are very similar numbers.|
Now, on to calculating a fair stock price.
|Pricing Method||Primace||Estimated Stock Value||Morgan’s Commentary|
|10-Cap||Determining how much the stock would be worth in 10 years, given 0% growth, based on owner earnings||~$65||Very low compared to the other calculated stock values. This shows how large of a role future growth plays into the stock price estimations (remember this method assumes 0% growth). Such a large dependency on growth, instead of current earning generation, makes me nervous.|
|Payback Time||Eight years with expected growth rate of ~25%. Chosen as a “conservative” estimation based on past growth rates. Calculation based off of free cash flow.||~$155||
I’m glad that these two values are so close, as it gives me confidence that a stock price around $155 would be a solid investment. At time of writing, FB is trending ~$164/ share.
|Margin of Safety||Calculate the price of the stock in 10 years based off of the price to earnings ratio, and 15% minimum acceptable rate or return. Then back calcuating what the stock price would be today based on that number. Divide the price by 50% (i.e. give it a 50% margin of safety).||~$154|
Are you asleep yet? Nope? Ok good! To put it simply when I finished crunching the finances, I was seeing dollar signs in my eyes. I wanted to buy Facebook stock, immediately. With growth numbers like this, I figured, there was no way I was going to lose money. And an event like this probably only comes along in a generation! Unable to tame my excitement, I bought two shares, paying a $4.99 commission fee (I would have bought more but that was all my little brokerage account could afford). Let’s chalk these up to being “practice shares” to let me experience real-time what it would be like to be an owner of Facebook (although if we’re being honest here, it was greed that made me buy them before I had completed my research).
The next step in my evaluation process was to research the company. Because I don’t want this post to be one zillion pages, I’ll give you the short story.
Facebook was founded by a genius named Mark Zuckerberg. I call him ‘genius’ because as a kid he invented a rudimentary form of AOL, before AOL even existed. Within its first year, FB hit over a million users. In 2006, FB launched the “share” button as well as the “News Feed”. At the time this causes an uproar among users who believed this constituted as an invasion of privacy. In 2008, FB introduced “chat” and in 2009 the “like” button. Around this time, “The Social Network” debuted. This movie painted a [somewhat fictionalized] picture of Mark Zuckerberg’s rise to power, portraying Zuckerberg himself as a money-hungry backstabber. This same year, Zuckerberg and his wife signed “The Giving Pledge”, promising to donate 99% of their wealth over their lifetime. It is unclear if these two events are related. In 2011, FB settles a dispute over user privacy with the Federal Trade Commission. In 2012 FB has its Initial Public Offering (IPO) and buys Instagram for $1,000,000,000. One year later, documents are leaked proving that the NSA uses Facebook activity and data to monitor users. Facebook denies involvement. In 2014, Facebook buys WhatsApp for $19,000,000,000. During 2016, Facebook is sued for allowing advertisers to discriminate based on race, disabilities, etc (which is illegal in some settings, like for housing). Facebook corrects the consumer targeting policy for certain industries (like housing). Also during this year, FB is highlighted as an perpatrator of “fake news” during the USA presidential elections. Facebook shuts down 30,000 fake Russian FB accounts. In 2017, it becomes apparent that FB users’ data is being harvested in ways that breach FB’s privacy agreements. Zuckerberg testifies in front of congress. Morgan buys 2 shares of Facebook stock.
I also took a look at FB’s Board of Directors. The board is filled with innovative names from many different industries and backgrounds. What stood out to me was the presence of not one, but TWO women who are both incredibly well qualified. Sheryl Sandberg *squeal* acts as Chief Operating Officer and is joined on the board of directors by Susan Desmond-Hellmann, the Chief Executive Office of The Gates Foundation. I absolutely love this, as one of the values I am voting for with my money is the inclusion and elevation of women within the corporate world.
If you want to read in-depth about the Board (which is surprisingly fun given the Board’s unique makeup), check out Facebook’s Board of Directors here.
As I look deeper into the history of Facebook, I start to become more and more conflicted. The financials looked good… SO good… yet, something doesn’t sit right. I didn’t like that Zuckerberg’s leadership style was so reactionary. The abuse of user privacy seemed to be a common theme in FB’s history. My first thought was that this was natural. After all, there was nothing like Facebook before Facebook- Zuckerberg couldn’t be expected to predict every issue that could possibly come up in a new platform such as this. As I read through my notes again however, I realized that it was not “every issue” he was expected to predict, but the same issue over and over again: user privacy.
This brings up an interesting juxtaposition, me the FB user, and me the investor. As an investor, I see FB’s massive data reservoir as a gold mine. This is what sets FB apart in the advertising space- the ability to target and identify potential customers like never before. Facebook’s moat is a mile long. Even if users follow through on the #deletefacebook campaign, many of them end up re-enabling their account of moving to Instagram (owned by FB). While Google also provides targeted advertisements, they don’t integrate nearly as seamlessly as a graphic on a news feed. I, myself, have experienced this. Scrolling through my news feed thinking “I love her outfit”… only to realize I don’t know the girl in the picture and it’s simply an ad.
Me the user on the other hand, feels differently. Realizing that Facebook had way more data on me than I could initially imagine scared me. I didn’t like that they could see other tabs that I had open on my web browser, or that friends could share access to my data without my consent. It scared me enough that I am trying to break the “Facebook habit” and look it it only once every few days to check on family.
So who do I choose? Investor Morgan or User Morgan?
[I wish there was some witty way to say this…] Both? Neither? After a week of bouncing back and forth, I realized that User and Investor should not be separated into two separate identities. Both these sides of me need to be 100% onboard when I decide to invest in a company. Despite FB’s delicious looking numbers, I’m going to pass on this one.
Except for my two shares. Those I will hold on to until I make enough to pay back my commission, and then I’m letting them go.
Sheryl Sandberg and Susan Desmond-Hellmann, if you ever read this post, please know that despite not buying into FB, I am a BIG FAN! Well done ladies!
My next investment dive: JetBlue
Stay tuned ladies and gentlemen!