Since my last post about Facebook on May 23, 2012, I have become an obsessive cynic. Today Facebook is trading at a PE of 1,903. Yes, 1,903. Facebook as a business is fundamentally flawed and it's valuation is even more flawed.
Facebook was founded in 2003 to connect people through the internet. I know, I was one of the original classes of college freshman who joined Facebook back in 2004. Facebook took an industry that was dominated by Myspace and became the purple cow. No longer was it hipsters and bands but it was just anyone looking to connect through the internet. Over the years, Facebook has grown to 1 billion users. Which brings me to my first point. There are only 2.5B active internet users in the world, at this point, Facebook can only grow another 250% assuming 100% market penetration. Trading at a PE like the above, should assume there is huge growth potential in the market - there isn't.
But the point of Facebook is no longer to connect people. The point is to advertise. Facebook trades at this crazy valuation because investors (and fools) believe that Facebook will change the way we communicate with customers. I say "we" because I am a small business owner who can speak from experience advertising on Facebook and not from "potential", which is Wall Streets perspective on how Facebook works. Facebook is great. It allows us to connect with our 12,000 fans through pictures and videos, allows us to communicate deals and specials and receive feedback all in the same place. A novel idea for sure. But how valuable can that really be? Advertisers spend about $500B worldwide annually. Currently, about 25% of that money is spent online. As the world races to, "get connected" surely that figure will increase. So let's say Facebook can possibly capture 50% of that market (if it will even be allowed by the FTC), that pegs us at $125B in revenue annually - currently more than AAPL. These assumptions are at least what investors are hoping for.
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