Let's break-down Facebook. I'm curious to hear thoughts on this from others.
Typically, I would want to see 10+ years of history in order to consider a healthy investment in a company. Facebook hasn't been public that long, so we don't have that data, but here are their growth numbers for the past 5 years.
Of course, those numbers are huge, and they won't be able to sustain such big numbers as they continue to grow. Currently, the "Analyst Consensus" growth rate is 27%. I'm going to be more conservative with this valuation and go with a 23% growth rate.
Current EPS is $4.62. At a growth rate of 23% that means it would take 3.13 years to double once. (The Rule of 72 makes this easy - 72 / 23 = 3.13).
So, what we want to do at this point is figure out what FB would be trading for in 10 years. This will help us put a value on the business today. Well, if they're going to double every 3.13 years, that means they'll double 3.19 times in 10 years (10 / 3.13 = 3.19).
Now that we know that, we can figure our future EPS by doubling the current EPS 3.19 times. 4.62 * 2 = 9.24, and that's one double. 9.24 * 2 = 18.48, and that's two doubles. 18.48 * 2 = 36.96, and that's three doubles. So to make things easy and stay conservative, we can stop there and reasonably assume that FB will have an EPS of $36.96 ten years from now.
So now to figure our future market price per share we need to figure out a future P/E. Again, with limited history behind FB this isn't as predictable as I would typically like, but if you look at the history of most big businesses you'll find that it's very common for the P/E in 10 years to be double the current growth rate. Again, we went with a growth rate of 23%, so we can assume a future P/E of 46. That's sort of up there, so once again, to be conservative I'll back that down to 40.
So now we have a future EPS of 36.96 and a future P/E of 40. This gives us a 10 year future market price of $1,478.40 / share.
Now, let's assume we want to earn 15% / year on this investment, which is an aggressive stance and makes what we're doing here very conservative. If we work backwards from the 1478.40/share price we can find the price we should buy at today if we want to earn 15% per year compounded. To do this we can simply divide 1478.40 by 4. This works because math is cool, and you can study why that works elsewhere if you're interested.
So, 1478.40 / 4 = 369.60. This means that based on our valuation, if we want to earn 15% / year on Facebook for 10 years, we need to buy at $369.60 or lower. This is our "intrinsic value", or what the company is actually worth today....to us...given our goal of 15% / year.
Of course, this would assume that everything goes as planned, and it continues to grow at the rates we expect, etc. How often does that happen? Hardly ever, right? So now we apply the Benjamin Graham / Warren Buffet "Margin of Safety" of 50%. So we simply chop our intrinsic value in half. 369.60 / 2 = $184.80.
So in theory, if we can buy FB at $184.80 / share, we're getting it for half off...a 50% discount on its current value...which already assumes a 15% compounded interest rate. So we've been extremely conservative with our calculations (we backed off the analyst consensus growth rate, we backed off the future P/E, we applied a 15% earnings in our calculations, and a 50% margin of safety.)
Finally, we can look at today's market price...and we see FB is currently trading at $169.62 quite a bit below our extremely conservative calculations.
The only thing going against it is that we don't have 10+ years of history to go by, so the numbers aren't quite as predictable as they would be otherwise. Again, though, that's why we went extra conservative.
So based on all of this, FB seems like a screaming BUY right now. Like, fill up the dump trucks with as much as you can. That said, I'm new to all of this, so I'm interested in hearing thoughts about how I broke this down and general opinions on my conclusion..??