Why Warren Buffett Would Never Buy Facebook

We are just weeks away from the latest report of what stocks Warren Buffett's Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) has been buying and selling -- and one thing is certain: Facebook (NASDAQ: FB  ) and Twitter (NYSE: TWTR  ) will not be on his list.

Source: Coca-Cola.

While Buffett may have not come out and said this directly, it is easy to believe the valuations of the two companies would be the main deterrent for the value-minded mega investor. But there are a number of reasons apart from a simple glance at price-to-earnings ratios that prove why he would never buy those social media stocks.

Beyond revenue
The two companies have been growing revenue at remarkable levels. Through the first nine months of 2013, Twitter's revenue grew at an annualized rate of 167%. Facebook's growth was as equally impressive for a company that was already so large, standing at 43%:

Source: Company SEC filings.  

The same cannot be said of Twitter's earnings power, as the company reported a net loss of $344 million in the 45 months from January 2010 to the end of last September, including a $133.8 million loss through the first nine months of 2013. In its S1 filing before the IPO, the words "net income" were never mentioned. "Net loss," on the other hand, was found 106 times.  

Buffett once said he operates with two rules: No. 1, "Never lose money," and No. 2, "Don't forget rule No. 1." It is therefore easy to see why Twitter would be immediately crossed off his investment consideration list. 

Facebook, on the other hand, tells a different story. If you exclude for share-based compensation, it has done a rather impressive job at growing its income:

Source: Company SEC filings.

While its trailing price-to-earnings ratio stands at 141, it's forward earnings ratio is at 49, according to the latest Thomson Reuters estimate. Although that is remarkably high, according to the September  holdings, Buffett also owns more than $750 million of Liberty Media  (NASDAQ: LMCA  ) , which has a forward P/E ratio of 33, according to the same estimate. 

Throw in Buffett's oft-repeated quote, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price," and perhaps an investment in Facebook wouldn't be out of the question. However Buffett's words in a letter to shareholders say exactly why he'd never buy Facebook.

Not in the business of picking winners
In that 2001 letter, Buffett said: "At Berkshire, we make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We're not smart enough to do that, and we know it."

While this was nearly 12 years ago, it was also right as the bubble from the technology boom began to burst; the S&P 500 would fall by more than 30% over the next two years, while the Nasdaq would drop by almost 45%.

Taking a step backward reveals that while Facebook currently sits on top of the social network landscape, the industry itself is largely in its infancy. While few would call Facebook an "unproven" enterprise, consider the recent Princeton study that projected the company would lose "80% of its peak user base between 2015 and 2017."

Facebook has refuted that claim, but its chief financial officer said it "did see a decrease in daily users specifically among younger teens." Just last week Time magazine reported "More Than 11 Million Young People Have Fled Facebook Since 2011." These findings bear witness to the reality that the business Facebook is in remains in the midst of fluctuation and growth, and it will likely be years before the ultimate best company emerges.

There is no denying that Facebook, as a business and a stock, has been on an impressive run over the years, but when considering it as a long-term investment like Buffett always does, there is also no denying that many questions remain.

More wisdom from Warren
While he may not buy Facebook or Twitter, the reality is, at last count Buffett owned 43 stocks worth more than $90 billion. He is one of the greatest investors ever and through the years, Buffett has offered up market-beating investing tips to shareholders of Berkshire Hathaway worth billions. If you want more from Buffett, now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

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  • Report this Comment On January 27, 2014, at 10:28 AM, atropicalone wrote:

    FB may be loosing teen users, but they have always been a fickle demographic, following the latest 'cool' trend. The real revenue for FB comes from adults, who have the buying power to act immediately on an ad without having to ask for parental permission. And ads geared to adults tend to be for higher ticket items, thus generating more revenue for everyone. Also, those same teens leaving FB now will become grownups. As their world expands to college days, brilliant careers, and having babies, FB will be the place that they will come back to; to stay in touch with their childhood friends, post photos of their children, and talk about their latest work and personal achievements. Now there's a revenue circle I can invest in.

  • Report this Comment On January 27, 2014, at 11:09 AM, inreality01 wrote:

    He would buy Facebook if it were a small business subject to the estate tax (death tax). This is where Buffet makes a ton of his money and why he is a big advocate of the estate tax.

    Of course, his assets are protected but he doesn't mind preying on others.

    The estate tax is a hideous tax that should be eliminated. It is immoral, unethical and quite frankly...... I think it isn't Constitutional.

    Buffet is a smart guy when it comes to enhancing his own wealth.

  • Report this Comment On January 27, 2014, at 11:38 AM, rusty7333 wrote:

    I agree! I did buy it and held for 6 months. I figured I should open an account and try it. I have been on since july and don't get Facebook. If you have nothing to do all day but report every thought and body function, then this is the sight for you. I sold my position on friday. I'm going to take the money and buy BRK-B.

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Patrick Morris

After a few stints in banking and corporate finance, Patrick joined the Motley Fool as a writer covering the financial sector. He's scaled back his everyday writing a bit, but he's always happy to opine on the latest headline news surrounding Berkshire Hathaway, Warren Buffett and all things personal finance.

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