Facebook Inc (NASDAQ:FB) stock is soaring. Up more than 100% over the past twelve months, shares have finally eclipsed the IPO price of $38. Given the company’s mobile dominance and revitalized growth, a rise is certainly justified. But has euphoria taken the stock too far?
A DCF valuation
A discounted cash flow, or DCF, valuation may not be perfect enough to serve as the sole basis for decision-making, but it’s a great starting point to give investors some context. Let’s see how Facebook Inc (NASDAQ:FB) measures up.
In the trailing 12 months, Facebook generated $2 billion in free cash flow, or FCF. To estimate the value of Facebook stock using DCF, we’ll need to come up with some growth rate for Facebook Inc (NASDAQ:FB)’s free cash flow going forward.
Facebook’s revenue in the company’s most recent quarter grew by 53%. We could use a growth rate close to 53% as a starting point for Facebook’s FCF growth, going forward, but that would be far too rosy a future. In a DCF valuation, conservatism is key.
Let’s assume Facebook Inc (NASDAQ:FB)’s FCF grows next year more closely in line with the company’s year-over-year average growth rate for the trailing four quarters: 41%. Then we’ll assume that as the company grows it faces less and less growth opportunities. In turn, FCF growth will decelerate by about 15% per year.
This scenario would look something like this:
| Year | FCF Growth Rate |
|---|---|
| 1 | 40% |
| 2 | 34% |
| 3 | 28.9% |
| 4 | 24.6% |
| 5 | 20.9% |
| 6 | 17.7% |
| 7 | 15.1% |
| 8 | 12.8% |
| 9 | 10.9% |
| 10 | 9.3% |
Given these assumptions, a DCF valuation yields a fair value for Facebook shares of about $49. Though $49 is higher than the stock’s value today, it doesn’t mean the stock is a buy. Investors should require a decent margin of safety from their fair value estimate — at least 25% for a high-growth company like Facebook Inc (NASDAQ:FB), since it’s hard to know how quickly the company’s high growth rates will decelerate in the future. Today, Facebook shares trade at about a 15% discount to $49.
In other words, our discounted cash flow valuation says the stock is a hold, but not a buy.
Comparing Facebook to Google
Facebook trades at 15.8 times sales. That’s a large premium over Google Inc (NASDAQ:GOOG)‘s 5.1 times sales. The same is true when you look forward to next year’s earnings. Facebook Inc (NASDAQ:FB) trades at 46.9 next year’s earnings estimates, more than 2.5 times Google Inc (NASDAQ:GOOG)’s forward P/E of 18.
