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 (FB +0.22%) and Twitter (TWTR +0.00%) 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 (LMCA +0.00%), 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.
