On Halloween, I was on Fox Business Network talking about Facebook's stock. On the same night when people were frightening each other, they really should have been frightened by Facebook's lofty valuations.
You see, the average investor largely doesn't know how to properly value a company. They know when clothes are on sale and at a good value. They know when food or fuel is cheap. But these are things they deal with and purchase each and every week, in some cases.
The average person doesn't know quite what to do with a stock. Oh, they generally want them because they know some great wealth can be built that way. Others even want stock to have something to talk about at cocktail parties. After all, it seems "smart" to buy stocks.
But that's about where it ends. From there, there is no "real" analysis. They buy because they are familiar with a product or service. They buy because their buddy is doing it. They buy because they see it mentioned a lot on the news. But they don't generally buy for sound reasons. And so it is with Facebook's stock right now.
Gerri Willis asked me that night on Fox Business Network what I thought about Facebook's stock and I told her that it was way overvalued.
But it didn't start being overvalued there. Heck, Facebook was overvalued when it first went public. You see, it was the ultimate stock to overvalue as an initial public offering underwriter. The masses were extremely familiar with what Facebook was and they knew tons of people who used it, literally around a billion people.
So it sounds good to invest in, right? I mean, why wouldn't you want to invest in something that a billion people use?
Well, for starters, Facebook is practically run by a kid that really doesn't understand all that much about business. He allegedly stole an idea from another and then made it popular. His intent wasn't even going to be to make money with it, until he was going public and realized that it would have to become a viable money-making business. He was content with it being a "cool social toy," in my opinion.
But even when Facebook CEO Mark Zuckerberg began to focus on earning money through ad revenue, the earnings still were a mile off from where the stock was trading. In other words, the price-earnings ratio (P/E) is simply insane.
How far off is it? The trailing P/E, which is based off of the last four quarters of earnings, is 123! The forward P/E, which goes off of projected earnings in the future, is still at a lofty 43.
In plain English, this means investors were willing to pay $123 for every $1 Facebook would take in in earnings. Even going forward, they're still willing to pay $43 for every $1 that Facebook is projected to make in the future.
To put this into perspective, a P/E of 6 to 12 usually shows that a typical company is undervalued. By the time the P/E gets to the 15 to 20, the typical stock is typically at least fairly valued and many times overvalued.
Well, a stock that is growing their earnings at a fast clip can sometimes support a P/E that is a bit higher than this, for instance, a P/E in the 21-30 range for a period of time. So a P/E of 43 to 123 is simply insane!
There's no way they could quickly increase their earnings at a fast enough rate to catch up to Facebook's current stock price. So what does that tell us?
It tells us that Facebook's stock price will have to come down. Does it have to begin to come down tomorrow? No! Stock prices can remain elevated above what they should for a period of time. However, it does tell us that weeks to perhaps months from now, Facebook investors will likely be longing for these price levels back on the stock.
So how far could Facebook's stock fall? Well, I told Willis that it really should be a $25 stock. However, the market may not allow it to fall quite that far. But I went on to tell her that I do expect the stock to eventually hit the low $30's.
Many of you have seen my previous articles on Facebook where I tried my best to steer you clear of this overpriced stock altogether. However, if you are in Facebook's stock presently, it may be prudent to consider exiting.
About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.
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