As Facebook Nears Breakeven, Are the Shares a Buy?

As Facebook Nears Breakeven, Are the Shares a Buy?

U.S. stocks opened sharply higher this morning, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average up 1.05% and 0.91%, respectively, at 10 a.m. EDT.

This morning's price action could be a delayed reaction to yesterday's conclusion of the Federal Reserve's July rate-setting meeting. The monetary-policy statement contained a few clues that the Federal Open Market Committee has tilted slightly dovish since the previous meeting. Furthermore, with no press conference, investors didn't have to face the horror of Fed Chairman Ben Bernanke outlining a timetable for the winding down of the Fed's monthly bond purchases, a.k.a. "quantitative easing" -- an "easy money" policy that has been supportive of stock prices. With that said, reading the mind of the market is a fool's errand -- this is no more than a hypothesis.

Facebook comes full circle
Yesterday, Facebook shares topped their $38 IPO offering price for the first time since their May 2012 flotation. How did we come full circle? On one hand, it's a milestone in a remarkable rally that has seen the shares more than double since their 52-week low. Still, with the stock closing at $36.80, investors who participated in the IPO have yet to break even on their investment, while the S&P 500 has risen 30% during the same period (and that figure doesn't include dividends -- a privilege Facebook shareholders don't get).

What went wrong? After all, Facebook is a bona fide growth company. Since the IPO, trailing-12-month revenue has jumped more than 50% to $6.1 billion, generating free cash flow of nearly $2.5 billion.

The trouble is that even those numbers couldn't support Facebook's absurd IPO valuation. At the end of the first day of trading, the shares were trading at 70 times the $0.55 earnings-per-share estimate for the next 12 months. The forward estimate now stands at $0.79 -- a robust 44% increase, but not robust enough to outweigh the collapse in the stock's price-to-earnings multiple from 70 down to 46.7.

Though today's prices might be in the region of the IPO price, buying the shares today is a different proposition than it was 15 months ago. They're cheaper, on a valuation basis, despite the fact that the risk is now lower -- with an extra year of operating history, the company has provided us with some confidence that the mobile ad business is sticking, for example.

Does this mean Facebook will provide investors with an adequate return from current levels? Not for my money, or not on a risk-adjusted basis, in any case. In fact, I would consider them a speculation more than an investment: The visibility for this business five or 10 years out is simply too hazy for my taste.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. 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.

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