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Why Facebook Might Still Grow Its Valuation or Justify It


Many stocks are going to look a lot cheaper the minute Facebook starts trading.

Sean Udall is the author of the TechStrat Report, a tech focused newsletter. The following is a free sample. Take a free trial!
MINYANVILLE ORIGINAL The Facebook (FB) effect (the market euphorically embracing a new, possibly disruptive technology) has been around for some time. Without it we would likely not have seen the early investment success of many other names -- think Yelp (YELP), Groupon (GRPN), Angie's List, and Zynga (ZNGA), just to name a few.

(One could argue the "success" of Groupon, but there's no doubt that the company has already made early investors a lot of money. I also think it's too early to declare Groupon dead, but that is another article/investment discussion.)
In my view, the Facebook deal will have potentially long-running ramifications with respect to the technology investment landscape in general. Consider, for instance, valuation.
Many stocks are going to look a lot cheaper the minute Facebook starts trading. At the high end of the IPO price range it's already sporting a $100 billion-plus valuation (actually close to $125 billion with increased allocation), a price-to-sales multiple exceeding 25x, and frankly I don't know if the price earnings ratio is meaningful, but it would be roughly 55 for the calendar year 2011 It's not negative and that's something.

According to the latest S-1 filed with the Securities Exchange Commission, Facebook's growth is in the 45% range. However, I think this might be a bit sandbagged and I expect to see Facebook's growth accelerate again. Even so, I think it's fair to say the days of 100% growth are gone.

As a comparison, when Google (GOOG) first traded, it carried a 14x multiple to sales and was still producing 100% growth. Clearly, Google was in an earlier growth phase and frankly a better deal on a valuation perspective. However, that doesn't mean Facebook is a bad deal.

In my view, while Facebook is done growing by triple digits, I also think it may be able to grow at a fairly strong rate (say 30-50%) for an extended period of time. If I'm correct and Facebook grows strongly for an extended period of time, it will either grow into its valuation or at least justify it.

Again for some comparables, both Baidu (BIDU) and VMware (VMW) have never traded at cheap valuations but have also sustained growth and have justified their early pricing premiums. For its part, Baidu is still trading at 17x sales nearly six years following its public offering. Personally, I'd much rather invest in Facebook at 25x sales than Baidu at 17x.

The question is, can I catch Facebook anywhere close to 25x sales.

New! The TechStrat Report by Sean Udall. Sean provides in-depth analysis, strategies and trades across the technology sector. Take a FREE 14 day trial.
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Author holds positions in GOOG, AAPL, FIO, EA, EMC

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