Please ensure Javascript is enabled for purposes of website accessibility

Facebook, Inc. Stock: Why Investors Are Paying a Premium Price

By Daniel Sparks – Mar 14, 2016 at 4:13PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Why does the market award Facebook with such a pricey valuation?

Despite it's premium valuation, shares of growth stock Facebook (META -2.36%) have appreciated 5% this year, even as the overall market declined. Why are investors so willing to reward Facebook with such an incredibly forward-looking valuation?

FB Chart

FB data by YCharts

Facebook stock isn't cheap
With a market capitalization of about $313 billion at the time of this writing, and a price-to-earnings ratio of 85, shares of the world's largest social network trade at a significant premium to other large tech companies. For instance, the average P/E ratio for stocks in the tech-heavy Nasdaq 100 index is 21. And the average P/E ratio for stocks in the S&P 500 is 23.

Part of this premium valuation, of course, is simply because the social network is growing fast. In Facebook's most recent quarter, for instance, revenue and net income soared 52% and 122%, respectively.

Still, a P/E ratio this high leaves little room for potential problems, such as rapidly decelerating growth or rising costs as a percentage of revenue. So, why are investors so generous with Facebook's valuation?

Here are two likely reasons:

1. Growth is accelerating recently. For three quarters in a row, Facebook's quarterly year-over-year revenue growth rates have actually been increasing. Year-over-year revenue growth in Q2, Q3, and Q4 was 39%, 41%, and 52%, respectively.

In a comparison in contrast, investors couldn't say the same about fast-growing social network company Twitter. Twitter's year-over-year revenue growth rates have been declining since mid 2014.

TWTR Revenue (Quarterly YoY Growth) Chart

TWTR Revenue (Quarterly YoY Growth) data by YCharts

The fact that Facebook has been able to -- at least temporarily -- reverse the deceleration of its revenue growth, provides investors incremental confidence in the social network's ability to maintain high growth rates over the long haul. Conversely, Twitter's consistent trend of decelerating growth could have some investors wondering when the deceleration could begin to moderate.

2. User growth is strong. Even at 1.59 billion monthly active users, Facebook's monthly active users continue to grow strongly. Indeed, the social network's sequential growth in monthly active users has largely remained at the same level during the last two and a half years. This is notable considering Facebook's already enormous reach.

Data from chart retrieved from SEC filings for quarters shown. Chart source: Author.

For comparison, Twitter's growth in monthly active users has been decelerating rapidly. And in the social network's most recent quarter, sequential growth actually came to a halt.

Data from chart retrieved from SEC filings for quarters shown. Chart source: Author.

Not all growth is created equal
Both Facebook and Twitter  are growing rapidly. But Facebook's growth appears steady and Twitter's uncertain. This has the market viewing both company's differently.

Facebook's combination of reaccelerating revenue growth and its strong user growth, has investors confident in the company's ability to execute and its potential to continue growing rapidly over the long haul.

Meanwhile, Twitter's stock price has plummeted 63% during the past 12 months, even as fourth-quarter revenue jumped 48% from the year-ago quarter. The company's deteriorating growth has investors uneasy about management's ability to execute.

Recent stock moves aside, investors clearly value Facebook's business more than Twitter's. The larger social network's price-to-sales ratio is 17.4. Twitter's is five.

It's worth noting that the market's confidence in Facebook doesn't automatically make the stock a buy. But this analysis of what investors love about Facebook stock shows that there are sometimes great reasons for one fast-growing company's outsized premium valuation compared to another's.

Daniel Sparks has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
META
$108.78 (-2.36%) $-2.63

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
356%
 
S&P 500 Returns
118%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/29/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.