Up 38% year-to-date compared to the S&P 500's gain of 10% during the same period, Facebook (META 1.54%) stock has been one of this year's best performers among large and megacap stocks. And with a $210 market capitalization, the social network is officially one of the biggest companies in tech. But after Facebook's sudden thrust into tech's biggest names, can investors expect much from the stock from here?
What is Facebook stock worth?
Pegging some sort of intrinsic value estimate on a business growing as rapidly as Facebook is extraordinarily difficult. To see just how hard it is, you can look at the rollercoaster general consensus the market has had on the company's value by looking at the stock's volatility since it went public.
Since Facebook went public at $38 per share in May 2012 the stock has fallen as low as $18 and hit prices as high as $81.16 -- all in a span of just two and a half years. Obviously, taking a stab at what Facebook is worth isn't easy.
But even though valuing Facebook stock is obviously hard, that doesn't mean the task should be completely dismissed. It's at least worth striving for a bit more perspective than "Facebook stock is expensive and has a high P/E ratio." And it's particularly important to try to get a better grasp on what the business is actually worth after the stock has soared so much higher recently.
One simple way to add a bit of perspective to Facebook's forward-looking valuation today is to look at a range of where the social network's annual earnings could potentially be in five years. After all, the stock is priced for big growth, so let's take a look at what Facebook may be capable of achieving.
Here is how Facebook has grown earnings recently.
Chart source: Author. Data retrieved from Facebook Q4 2014 earnings slides.
Combining rapid revenue growth and operating leverage, Facebook's earnings have grown robustly since the company went public. But it's clear that slowing revenue growth and slowing positive effects from operating leverage will slow the company's earnings growth, going forward. Triple digit growth in earnings shouldn't be expected to continue sustainably for a long period of time for any business -- even Facebook.
Unsurprisingly, the consensus analyst for Facebook's earnings-per-share growth in the coming years is much lower than recent growth, at 36% -- much slower than recent EPS year-over-year growth that has treaded around triple digit figures in some quarters.
Prospects for Facebook stock
So, where can Facebook's earnings go from here? Let's estimate the company will see earnings per share grow anywhere between 25%-40% annually over the next five years. This would put the social network's non-GAAP annual earnings about somewhere between $4.70-$8.20 per share.
Where would this sort of growth put Facebook stock? Assuming that, in five years, Facebook earns a price-to-earnings ratio that is a slight premium to Google's today (28), Facebook stock could reasonably trade anywhere between $141 ($4.70 in annual EPS times a 30 P/E ratio) and $287 ($8.20 in annul EPS times a 35 P/E ratio).
What sort of annual return would these prospective share prices for Facebook stock five years from now earn investors? Anywhere between about 13.5%-30% -- not too shabby at all.
Of course investors should take any forward-looking projection with a grain of salt. Lacking a crystal ball, making any forward-looking projections welcomes in a lot of uncertainty. But, the point is, Facebook's profitable business model combined with its monstrous growth do matter, and after giving them some credit, Facebook stock doesn't look as expensive as it may seem at first glance.
Does this mean Facebook stock is a buy? Not necessarily. If there's anything to eye dubiously on the Street, it's rosy forward-looking assumptions. Investors should tread carefully when they consider buying stocks priced as optimistically as Facebook. But, on the other hand, the best businesses hardly ever trade at a meaningful discount, so waiting on shares to look like a bargain may never happen.
In an attempt to truly give uncertainty the weight it deserves and embrace conservatism, I'll peg an intrinsic value estimate of Facebook shares of about $100, but still demand shares to trade at a solid margin of safety of at least 30%. In other words, I would wait for shares to sell-off to $70 or lower before I consider snapping up shares. This gives me room for error in my optimistic projections.
