This Facebook Bubble Story Needs Debunking

In Irrational Exuberance, Yale's Robert Shiller looks at the dynamics behind bubbles. "Stories" are one of the key elements -- simple narratives brokers and investors pass on to each other, containing a rationale for participating. The Facebook (Nasdaq: FB  ) IPO bubble is no different from any other in that it has been (and continues to be) fueled by a number of stories. It's important to analyze those stories so as not to let shortsightedness and greed sweep you along in their tide, so I'm going to debunk one of them today.

"Buying Facebook now is like buying Google at its IPO!"
This is the structure of the underlying syllogism:

Major premise: Investors who bought shares at Google's (Nasdaq: GOOG  ) IPO have done very well.

Minor premise: Facebook is a transformational business, much as Google is.

Conclusion: Investors who buy Facebook shares now will do very well.

The major premise is true, but the minor premise is false (I've already laid out 3 Reasons Facebook Isn't Google). However, even if both premises were true, the conclusion still wouldn't be. It's important to understand why.

The worst investing article I ever read
The most egregious example of this flawed leap of logic I've ever seen was the product of MarketWatch columnist John Dvorak in 2009, trying to justify a plainly ludicrous $20,000 price target for Google. In "Will Google become Microsoft?" he wrote:

I do not see any way of stopping [Google] for at least another decade. It's on the same carnival ride we witnessed with Microsoft (Nasdaq: MSFT  ) . Even at today's closing price, Microsoft's stock value essentially has grown by around 200 times since its IPO.

That would mean Google shares could hit the equivalent of $20,000, give or take a few thousand dollars. Of course, Google is in a completely different business using a different strategy. But dominance does have a way of rewarding investors.

The point is that Google has given us only glimpses of its potential, and if we were to equate it with Microsoft, it would be like buying Microsoft stock today for 30 cents to 40 cents a share.

As I remarked privately to a handful of Motley Fool analysts and editors at the time, the author didn't even think to ask whether the two companies had different market values at the time of their respective IPOs! In fact, Google's market value at its IPO price was $23 billion, dwarfing the equivalent value for Microsoft ($519 million) by a factor of nearly 45. Factor that out of Dvorak's 200 times expected return, and you might expect to quadruple your money. That's quite a difference!

A $6 trillion market capitalization?
Here's another way to think about Dvorak's absurd conclusion: Since his premise for Google shares at $20,000 was that Google could "become Microsoft," he might have asked himself why Microsoft itself never achieved a $5 trillion-plus market capitalization -- the value implied for Google if each share were worth $20,000.

There is no sense in extrapolating post-IPO returns from one company to the next when the two come public at completely different valuations, and just as Google came public at a much higher valuation than Microsoft, Facebook came public at a much higher valuation than Google. Let's put some numbers on the Google-Facebook comparison:

 

Google

Facebook

Market capitalization, end of first trading day $27 billion $112 billion
Current market capitalization $189 billion $87 billion

Sources: Company filings, S&P Capital IQ, Yahoo! Finance.

In other words, if we do a side-by-side comparison of Facebook and Google's market values, the argument suggests that if Facebook's market opportunity turns out to be similar to Google's and if, over the next seven years, it executes as well as the search champion has over the prior seven (both are huge leaps of faith), Facebook can expect to multiply its market value by two (in real terms.)

15% annualized: the impossible dream
That level of value creation would deliver investors with a decent expected return -- if it were a baseline scenario -- but given that this corresponds to a "perfect dream" scenario, it is nowhere near enough to justify the material downside risks attached to more realistic outcomes.

With much less hype, one social-networking company is executing brilliantly on a sounder business model. The Motley Fool's technology analysts think investors should Forget Facebook -- Here's the Social Networking IPO You Should Be Buying.

Fool contributor Alex Dumortierholds no position in any company mentioned. Check out his holdings and a short bio; you can follow him on Twitter. The Motley Fool owns shares of Facebook, Google, and Microsoft. Motley Fool newsletter services have recommended buying shares of Google and Microsoft and creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (8) | Recommend This Article (9)

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  • Report this Comment On June 03, 2012, at 7:16 AM, applefan1 wrote:

    Why are you guys comparing Facebook with Google? Facebook is a social network service similar to Classmates, Linkedin, MySpace, MyLife and only Google+ (which hasn't shown it actually makes a profit)

    People use Google to search for information, products to buy and CORPORATIONS pay money to have their sit listed at the top of the search results and there is a fair amount of advertisements being placed. There are very little ads being placed by major corporations in Facebook as companies have their Facebook web site they have for free and people just link to them.

    They bought Instagram for over $1 Billion. How long will it take for them to make their money back from revenue based on people using that software?

    The growth rate for number of users has slowed down tremendously and people using it on a daily basis isn't that many.

    Google has YouTube which people accidentally press the ads constantly. It is almost impossible not to. That makes them lots of money.

    Google wasn't really known about until 1999, which is when people actually started using it.

    Look at the revenue increase from 1999 to present. Facebook's been around for many years before this IPO and their revenue isn't doing that well considering the number of accounts and daily active usage.

    Google has at least 88 Billion searches a month. Facebook has 500 Million active users doing what? Linking their friends, posting a photo, posting a 1 or 2 sentence message, or text messaging. That's basically what people do in Facebook. Some (small amount) play on-line games.

  • Report this Comment On June 03, 2012, at 9:28 PM, TMFAleph1 wrote:

    @applefan1

    You completely miss the point of my article, which is that, even were we to *assume* that Facebook is similar Google (which many people appear to believe), the top-of-the-range returns Facebook could hope to achieve are good, but hardly earth-shattering.

    I don't happen to believe that Facebook *is* comparable to Google in any relevant manner; in fact, last month I published an article titled, '3 Reasons Facebook Isn't Google':

    http://www.fool.com/investing/general/2012/05/20/3-reasons-f...

  • Report this Comment On June 04, 2012, at 11:02 AM, glynn1950 wrote:

    Google " The Koch brothers Exposed" and see who the right wing republicans tea baggers and facebook take their orders from!!!!

    Facebook is now disabling peoples accounts (Censorship) that post anything against the Koch brothers, Roves’ PAC or the tea bag party on any website that they monitor!!!!

    You can not post on any of your local news sites when Facebook censors you!!!!

  • Report this Comment On June 04, 2012, at 12:30 PM, HectorLemans wrote:

    That was a disjointed rant ^

    In regards to comparing Facebook to Google, I think in very broad terms it's a reasonable thing to do since they both have to make most of their money off online advertising. And that right there is what would scare me off of buying any Facebook stock - Google has a huge amount of time and effort involved in online advertising and will fight to the death any major competitors.

  • Report this Comment On June 04, 2012, at 2:09 PM, TMFAleph1 wrote:

    @HectorLemans

    Right now, it's really not the same kind of advertizing. Google's is targeted and useful. Facebook's is irrelevant and annoying. Guess which one is more likely to capture advertisers' dollars?

  • Report this Comment On June 04, 2012, at 8:46 PM, turb0kat wrote:

    Alex, I appreciate and agree with most of this article but your claim that Facebook isn't a transformational business is utterly asinine.

  • Report this Comment On June 05, 2012, at 12:02 AM, TMFAleph1 wrote:

    @turb0kat

    Facebook as a platform may be transformational, but that is separate consideration from assessing Facebook's *business* which is, to date, decidedly pedestrian. Right now, Facebook -- the business -- is nothing more than banner ads. It may turn into something more at some stage, but it isn't more than that now.

  • Report this Comment On June 16, 2012, at 6:03 AM, thidmark wrote:

    "Facebook is now disabling peoples accounts (Censorship) that post anything against the Koch brothers, Roves’ PAC or the tea bag party on any website that they monitor!!!!"

    I get plenty of left-wing bilge from my "progressive" friends, which is one reason I hardly visit Facebook anymore.

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