After a Great Rally, Should You Take Profits?

It has been a great run for Facebook as shares have more than doubled over the last three months. Yet, as new services begin to roll out, and investors brace for third-quarter earnings, is there more upside past $50 for the social media giant, or should you trim your position?

Surpassing expectations
It has been nine weeks since Facebook released a perception-changing second-quarter report, one where mobile revenue led to an impressive top-line showing.

As we've seen with companies such as LinkedIn and Tesla, cult stocks can continue to surpass all levels of reason so long as company outlooks remain high. In the case of Facebook, much of its outlook is tied to mobile growth, and also several new service rollouts.

Rolling out new services
One of those new services is a payment system, originally reported to be "like PayPal." Last month, my article "Could 2 New Services Create Billions in Annual Sales?" looked at the potential implications of both the new payment system and also video advertising.

In regards to the payment system, PayPal has 132 million users and contributed $1.6 billion to eBay's top-line during its last quarter . This accounted for PayPal revenue growth of 20% year-over-year and was complimented with 2015 sales guidance between $9.5 and $10.5 billion for the segment .

In theory, Facebook, with its 1.2 billion users, could have made a killing with a service that mimicked PayPal. Even if 5% of Facebook members would have used the service, it would have had over 60 million users, and could've created billions in long-term annual revenue.

A disappointing rollout
Instead, Facebook is launching an autofill solution to mobile payments, but won't process payments. As a result, third-party processors such as PayPal and Braintree will handle the actual payments. Last week, the WSJ reported that eBay is close to buying competitor Braintree, which given the Facebook news, would make sense for eBay.

Now, with all things considered,  this move might be bad for Facebook and great for eBay. It is bad for Facebook for the reasons noted, as they lose out on potentially billions in annual revenue.

Clearly, Facebook's agenda is to gather additional information, which some believe might be used to better deliver targeted ads in the future. And who knows, maybe one day Facebook news feeds will consist of products for sale that you actually want to buy. Then, perhaps Facebook's strategy of collecting data and knowing what the consumer is buying would work.

In the case of eBay, PayPal not only dodges the bullet of Facebook entering its payment processing space, but also gains Facebook's 1.2 billion users who may elect to use this service. Hence, PayPal could see a boost in volume once the service is integrated, making it very surprising that eBay's stock has not seen a pop on this news. Given the fact that PayPal is about 40% of eBay's total revenue, and nearly all of its profit, I would think this news should be a huge win for eBay .

Looking at Facebook, the company still has its upcoming video advertising service, and as I explained in the noted article, this one service could add more than $3 billion in annual revenue for Facebook. However, given this latest development regarding their payment system, it is hard to know for certain what Facebook might have planned for video advertising. It is possible that they do something with video advertising that we don't expect, and is not nearly as lucrative. Regardless, it might be time to take some Facebook profits off the table.

Pricey in an expensive space
If we compare Facebook to other social media companies, it is still relatively cheap. Facebook trades at 19.3 times sales, while LinkedIn and Yelp trade at a whopping 22 and 24.5 times sales respectively. Each of these companies have problems of their own, including competition from the much larger Facebook.

LinkedIn has more than 200 million users but has very low user engagement, having become a career networking site. With poor user engagement , it is tough to imagine a scenario where LinkedIn can ever gain as much knowledge about their users' buying preferences compared to Facebook.

In the case of Yelp, it has great reviews and definitely knows what the consumer likes. However, Yelp's spending continues to outpace its revenue growth , leading many to wonder if it'll ever obtain profitability, and if long-term growth is sustainable without massive spending. Facebook is actually decreasing its capital expenditures and is seeing revenue growth exceed costs , which is what long-term investors seek.

Final thoughts
With all things considered, Facebook doesn't look bad compared to its competitors. However, this fact alone doesn't make a great investment, and at 19.3 times sales, Facebook is pricey.

As a long-term investment, Facebook might be a golden opportunity, and who knows, it might very well support the same 22 times sales valuation as LinkedIn, and then trade at $55. However, upside of $5-$6 is very limited considering the risks. And with a $120 billion market cap, Facebook is by far the largest company to trade at the 20 times sales range.

Other tech giants such as Google or Yahoo trade between five and seven times sales, and as Facebook continues to grow, my guess is that a 20 times sales valuation can not be supported long-term. Therefore, with many analysts having a price target of $50 on Facebook, and revisions lurking, now might be a good time to decrease your position. Because one thing that never hurt anybody, is taking profits after massive gains, especially when product launches don't meet expectations.

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Brian Nichols owns Facebook. The Motley Fool recommends eBay, Facebook, and LinkedIn. The Motley Fool owns shares of eBay, Facebook, and LinkedIn. 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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