Social media giant Facebook (NASDAQ:FB) recently reported quarterly earnings results. If you look at some of the widely reported earnings numbers, you'll see that the company brought in net-income of $1.437 billion or about $0.50 per share.
However, these widely reported numbers are what are known as "Non-GAAP" ("GAAP" stands for "Generally Accepted Accounting Principles"). These numbers, according to Facebook's most recent earnings release, exclude amortization of intangible assets as well as stock-based compensation.
If we look at the GAAP numbers -- that is, the numbers that factor in the aforementioned items -- Facebook doesn't look anywhere near as profitable.
Just how big is the difference?
The difference between Facebook's non-GAAP and GAAP numbers is actually pretty startling. Net income in the most recently reported quarter on a GAAP basis was $719 million, translating into just $0.25 per share.
Further, on a year-over-year basis, although the company saw earnings per share increase from $0.43 to $0.50 (a 16.3% increase) on a non-GAAP basis, on a GAAP basis Facebook actually saw its earnings per share decline from $0.30 a year ago to $0.25 in the most recent quarter.
What's driving the reduction in (GAAP) earnings?
Taking a look at Facebook's financial results for the quarter, it's pretty easy to see that the pressure on GAAP earnings is driven by substantially increased expenses. Research and development spend surged from $492 million in the year-ago period to $1.17 billion, marketing and sales ballooned to $626 million up from $358 million, and general and administrative rose from $197 million to $305 million.
Now, from a long-term perspective, the increased spending is good to see; Facebook has the wherewithal to continue to invest in its business and it should strike while the iron is hot.
However, when it comes to trying to get a handle on the value of the stock, given that share based compensation expense is such a significant part of the company's total operating expenses, I don't think the non-GAAP numbers are all that meaningful.
In this light, Facebook doesn't look all that cheap
Analyst's estimates of Facebook's future earnings tend to be in non-GAAP form, which I believe creates a false impression that Facebook is reasonably priced. For example, analyst consensus calls for the company to earn $2.01 this year and $2.67 next year.
As of writing, Facebook stock is trading at about $94.53, meaning that the shares are priced at roughly 47 times this year's expected earnings and 35 times next year's earnings. By no means is this "bargain bin" territory, but for what appears to be a solid growth story it's hardly in "nosebleed valuation" territory.
However, on a GAAP basis, Facebook stock looks significantly more expensive. Year-to-date, Facebook's non-GAAP earnings have been a little over twice its GAAP earnings. If we naively divide full-year estimates by two to get a sense of where Facebook's GAAP earnings are expected to be for the year, the company is trading at about 94 times earnings this year.
The risk/reward doesn't seem to favor a long position
At a market capitalization of about $265 billion and with the shares trading at about 94 times projected 2015 earnings on a GAAP basis, it seems as though a lot of good news has been baked into the share price at this point.
I'm not a buyer of Facebook shares here; although the company continues to execute well, I believe that at current prices there isn't much upside to be had, but any stumbles could lead to substantial downside.