Facebook, Inc. Stock Nearly Doubles Since Its IPO -- Buy, Sell, or Hold?

A better-than-expected second-quarter report sent Facebook stock to new highs. After doubling since its IPO, is it time for investors to take their profits? The answer may surprise you.

Daniel Sparks
Daniel Sparks
Jul 27, 2014 at 3:20PM
Technology and Telecom

After Facebook (NASDAQ:FB) reported better-than-expected quarterly earnings last week, shares soared to new all-time highs, hitting $76.74 before settling at $75.19 when the market closed on Friday. The report sent the stock up 5% and is helping the social network hold ground about 30% higher than where it was trading just three months ago. At these new highs, is Facebook stock beginning to look overvalued?

FB Price Chart

FB price data by YCharts

The wild performance of Facebook stock
These levels have unique significance for two reasons. First, $76 is double Facebook's IPO price of $38 -- a valuation that was once heavily criticized as bubble-like when the company initially began trading on the Nasdaq just over two years ago. Second, $77 would mark an impressive $200 billion market capitalization for the company -- about one-third of Apple's and half of Google's.

FB Chart

FB data by YCharts

To say the least, Facebook CEO Mark Zuckerberg has surprised the Street. There was even a period in the months following the social network's IPO when the stock traded below $20. Investors who bought at these levels have enjoyed a 300%-plus return.

The stock's performance has largely been driven by Facebook's shift to becoming a mobile company. As it turns out, mobile ads built into the Facebook newsfeed are far more effective than the ads on the desktop version of the site that sit on the side of the feed. Of course, Facebook has also brought similar ads into the newsfeed on desktop, after seeing how successful they were.

Mobile advertising has soared from 0% of Facebook's advertising to 62% in under two years. 

Data for chart retrieved from SEC filings.

Not the dot-com bubble
But no matter how well Facebook has performed, some investors may have difficulty understanding the social network's valuation. Priced at about 20 times sales, compared with Google's 6.4 ratio, it's clear the market continues to have enormous expectations for the company.

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Even Federal Reserve Chairwoman Janet Yellen called out the valuations of Facebook and other social peers earlier this month, saying they are "substantially stressed."

While it may be tempting to relate the seemingly exuberant valuations of social stocks like Facebook to those we saw in the dot-com bubble, it's worth nothing that Facebook is not a revenue-only business. Its business model, in fact, has proved to be extremely scalable; it's becoming increasingly clear that the company boasts significant operating leverage, enabling margins to grow meaningfully as revenue grows. This sort of scalability is lifting Facebook's EPS at incredible rates.

FB Normalized Diluted EPS (TTM) Chart

FB normalized diluted EPS (TTM) data by YCharts

In Facebook's most recent quarter, revenue grew 61% from the year-ago quarter and EPS soared 121%. Or, viewed another way, Facebook's net income more than doubled from 488 million in the year-ago quarter to $1.09 billion in Q2.

While the future growth priced in to Facebook stock is too speculative to call it a buy, especially after the stock's recent run-up, the continued excellent underlying business performance makes the stock a hold.