# Facebook Inc (FB) Investment Valuation

December 28th, 2012 Posted by No Comment yet

Facebook Inc (FB) was founded in 2004 by Mark Zuckerberg. Headquartered in 1 Hacker Way, Menlo Park, California 94025. FB had 1.52 billion daily average users as of December 2018.

## Facebook Value Investing Approach

The method of valuation approach for Facebook Inc was based on Discounted Model.  The historical data were gathered and then I came up with the forecast financial data and ratios to come up with the net present value of the  6th year period. Net present value is one way to decide if an investment is worthwhile by looking at the projected cash inflows and outflows.  Cash inflows are the expected cash that the company can be generated for the period. Cash outflows are the expenditures to be incurred from generating cash inflows.

## Discounted Model

This model will show us how to calculate the value. I will walk you through every step of the calculation. The table below shows the historical value of Facebook Inc.  The formula is:

Where:

• Vo is the value of the equity of a business today.
• CF1 to CFn represents the expected cash flows (or benefits) to be derived for periods 1 to n.  The discounted cash flow model is based on time periods of time of equal length.  Because forecasts are often made on an annual basis in practice, we use the terms “periods” and “years” almost interchangeably for purposes of this theoretical discussion.
• r is the discount rate that converts future dollars of CF into present dollars of value.

The equation above is the basic discounted cash flow (DCF) model.

#### Discounted Model without Terminal Value

The data show the historical data of income and expense for Facebook Inc from 2007 to 2012.  The net income is cash inflows.  The present value was also calculated by net income over 1 plus capital rate to the power of n.

The table above will show us the historical equity of Facebook Inc as well as the return on equity. The return on equity was calculated by net income over equity.  The average return on equity was \$0.17 for every dollar of earnings.  The average ROE was 0.17. On the other hand, the earnings per share were calculated by net income over the number of outstanding shares for every period. Since Facebook Inc was new in IPO, the only available market price were 2011 and in 2012, therefore price to earnings was calculated only in 2011 and in 2012, which is seen above at \$38 and \$27.07 per share. Therefore, the price to earnings was calculated at market price over earning per share. I have used forward price to earnings ratio of 48.

#### Income on the sixth year

In the table shown above, we want to get the income for the 6th year as well as the present value of net income.  On the other hand, the value of Facebook Inc of the 6th year was also calculated.  How did I do that? First, I have to calculate the net income in the 6th year. The calculation of net income at year N was, the last projected equity multiplied by the average return on equity and we get the projected net income at \$5.8 billion.

The projected equity from 2007 to 2017 was also calculated simply by multiplying the projected equity per share to the number of shares outstanding from 2013 to 2017. Moreover, the present value of net income was \$2.5 billion calculated as net income on year N over 1 + capital rate on the power of 6. While the value of the entire business of Facebook Inc at the 6th time periods was \$ 121 billion discounted today. The value of Facebook at \$121 was calculated by net income multiplied by the multiplier of 48. From here, we get the value of the 6th year discounted today at present date.

## Equity and Earnings Model

This spreadsheet shows the historical equity, net earnings, and the retained earnings, as well as the projected for the five-year period. The return on investment can also be seen and the income growth for Facebook Inc.

The data shows us the future equity and earnings per share for Year 1 to Year 5. The projected retained earnings were calculated as well as by adding earnings and deducting dividends to the equity. The average ratio was calculated as well.

The present value of equity per share was \$5.61 at a rate of 17 percent, you would have \$14.39 at the end of 6 time periods, which is the future value. In other words, a future value of \$14.39 is equal to a present value of only \$5.61.  This means, having a choice of taking an amount higher than \$5.61 today and taking \$14.39 at the end of the 6 year period, you would have been taken the money today.  By doing so, you will have a chance to invest the higher amount at 17 percent for the same 6 year period, which will give you at the end more than \$14.39. The net income in Year 5 was \$2.45 per share discounted today at the present time.

## Benjamin Graham’s Intrinsic Value

One of the strategy by Benjamin Graham in investing is by using the intrinsic value. Graham created the formula for intrinsic value and used to value stocks. In the finance world, he is famous for his margin of safety. Most investors required a margin of safety which is the measure of risk equal to the amount by which stock price is below intrinsic value.

The formula for Intrinsic Value is:

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

The explanation in the calculation of intrinsic value is the following:
EPS or the company’s last 12-month earnings per share;  G is the company’s long-term (five years) sustainable growth estimate; 9 is the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham  (Graham  proposed an 8.5, but we changed it to 9); and 2 as the average yield of high-grade corporate bonds.

#### Intrinsic Value Table

The earnings per share average were 0.15, while the growth which is the return on equity was 1.85 percent average. The average ratios of Facebook were not that impressive, because, during its first two years, 2007 and 2008, the company suffered losses as return on equity factors net income. Annual growth, on the side note, was \$9.04 average. Moreover, the intrinsic value was \$1.42 average. If I consider only the last three years, the average intrinsic value was \$2.75.

#### Explanation

The graph above shows us how the true value of the stocks of Facebook Inc is moving. The intrinsic value was below the linear trend line in 2007 and 2008. For reason the intrinsic value was negative, meaning there was zero value of Facebook Inc’s during those periods. It started to soar in 2009 where the point of intersection was, until 2011 but falls down in 2012 at a rate of 57 percent. The net margins in 2012 dropped to 4 percent from 18 percent in 2011. The margin of safety is measured at 40-50 percent of the intrinsic value as the requirement of Graham in buying stocks. Buying at this level, you put an allowance to future unseen risks.

Since there was a zero margin of safety for Facebook Inc the stock price is greater than the true value of the stock. This also means that the stock of FB is trading at an overvalued price.

#### The Enterprise Value

If you were internet savvy, you would’ve known that FB was new in IPO. As a result, the enterprise value was calculated for the period 2012. The enterprise value per share was \$19.79. The cash and cash equivalent represent 20 percent of the enterprise value, thus the enterprise value was lesser by 20 percent against the market price. For investors who are buying the entire business of Facebook Inc to date, December 21, 2012, will cost you \$51.7 billion at \$19.79 per share.

#### Conclusion

The value of Facebook at the 6th time periods was \$121 billion discounted today at the present time. The projected net income at year N was \$5.8 billion and \$2.5 billion valued at present. While, the average return on equity was 0.17 from 2010 to 2012 ratios, but the actual was 0.10 from 2007 to 2012 ratios. The reason is that Facebook Inc suffered losses in the first two periods. Thus, we include the last three year period only and the result was 0.17. The price to earnings ratio was \$48.  I think the losses are on Facebook.

Moreover, the present value of equity per share was \$5.61 at a rate of 17 percent, you would have \$14.39 at the end of 6 time periods, which is the future value. In other words, a future value of \$14.39 is equal to a present value of only \$5.61.

#### The margin of Safety (MOS)

The margin of safety by Benjamin Graham, Facebook Inc has zero margins of safety in 2012. The intrinsic value was very low because the growth of Facebook deteriorates in 2012 and negative growth during the first two years; between 2007 and 2008.  The intrinsic value average was \$1.42 from its 5 year period, in 2012 it was \$1.73.

The enterprise value was \$51,748 at \$19.79 per share. Enterprise Value is the cost of buying the entire business to date, December 21, 2012. The market price to date was at \$27.71 per share. Facebook has zero debt and its cash and cash equivalent represent 20 percent of the enterprise value. Thus the enterprise value was lesser by 20 percent against market value.

In addition, Facebook Inc has the potential of generating revenue out of its advertisements or real-time bidding value. According to one of FB’s partners in advertising, the company is generating almost 4 times the return on ad dollars than another real-time bidding system with its current Facebook Exchanged or FBX. Moreover, Facebook’s revenue from real-time bidding represents only 85 percent of the whole revenue from advertising. Plus other generating activities that Facebook can offer.  Also, the company had already reached it’s 1 billion milestones before this year ends surpassing the projection on FB.

Overview, Facebook has great potential in many areas and with its huge opportunity for advancement. Therefore, I recommend a BUY on the stock of Facebook Inc (FB) because of its huge potential.

Research and Written by Criselda