I have been fielding a lot of questions lately about the Facebook (FB) IPO. What went wrong? Should I buy it now? Recently the managing directors of Tweedy, Browne Funds, a well respected value manager offered the following commentary on the valuation of the Facebook IPO in their 3/31 letter to shareholders.
“As you can see in the above chart, you could buy roughly the same amount of earnings that Facebook produced in 2011by simply buying Heineken Holdings for $13.5 billion, and you would then have $86.5 billion left over to go shopping for other companies in our Funds’ portfolios. For the remaining $86.5
Billion, you could buy Emerson Electric, Devon Energy, G4S PLC, Torchmark, NGK Sparkplug, Daily Mail, and Teleperformance, and still have roughly $700 million in walking around money. When all is said and done, for Facebook’s IPO price, you could purchase the above group of leading companies in their respective fields at a price/earnings ratio of 10.4 times estimated earnings. As a group, these companies produced nearly ten times the earnings of Facebook in 2011, and paid dividends of over $2 billion. According to our calculations, Facebook would have to compound its current earnings at an annual rate of approximately 35% over the next ten years to catch up to the amount of earnings produced by the selected companies held in the Tweedy, Browne Funds, which are compounding their earnings at a more realistic 7% per year Now, it might very well turn out that Facebook performs as expected and compounds at even more attractive rates, producing superior returns when compared to the stocks selected above from the Tweedy, Browne Funds’ portfolios, but the stakes are high given the lofty IPO price. Very high expectations are built into stocks that trade at 100 times earnings. If it disappoints, the results for its investors could be disastrous.”
The above is a classic explanation of what can go wrong (and did) when investors throw valuation out the window. Investments in even very good assets can go awry if you overpay for ownership. The take home message for the small investor is this: with Facebook, you’re paying 100x’s earnings for an unproven business model. If you’re an investor, there are myriad easier and safer ways to earn a decent return. This link will take you to the full Tweedy Browne annual report;