Is Facebook fairly valued?

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Individuals and corporations often desire to grow economically. Obviously, investment is crucial for a continued growth, as people and businesses acquire properties for future income. It may take two forms, which include fixed and variable income investment. Fixed income investment comprises of fixed deposits, bonds, and preference shares (Omololu). Conversely, variable income investment involves owning a business or property. A bond is considered a debt instrument developed for creating capital. The bond issuer must pay the specified amount at an agreed date in the future. American social network Facebook is the largest and most influential social media platform globally. Different views are given about the value of this website, as it is often undervalued in terms of price-to-earnings ratio, price-to-book ratio, future growth, and discounted cash flow; it is also crucial to examine the reasons why people buy government and corporate bonds in addition to providing corporate loans and the risks involved.

Why Facebook is not Fairly Valued

Facebook is often underestimated as the economists rely on the price-to-earnings (PE) ratio to value Facebook’s stock. The company is growing at a fast rate and the trailing PE ratio cannot be a suitable metric to assess the profits of the company. It only compares the stock price with the earnings per share (EPS) from the previous twelve months (Zanoni). Moreover, the PE ratio is determined relative to other companies in the same industry such as Google. Even though the firms may have some common features, they are affected by different internal factors. Therefore, Facebook’s value should not be based solemnly on the PE ratio.

To measure Facebook intrinsic value, discounted cash flow analysis is often used along with several growth assumptions. Here, it should be mentioned that the investors will always apply the assumptions that they perceive to be suitable to them. Here, the FB which future earning prospects are much more promising. Thus, the company has the biggest user base and continues to attract more users for its future success (Zanoni). Consequently, the worth of a business will rise, as it gradually increases its average revenue per user in the coming years. In addition, one would be able to observe a certain growth of the company as the advertisers continue to rely on social media platforms to reach their clients (Kobayashi-Solomon). Facebook, in its turn, can offer the advertisers the information required to target their customers more efficiently. Its large daily and monthly user base remains to be a dream of many advertisers, and they are always willing to pay for it. Thus, the anticipated 10% annual growth is feasible since the company grew by over 30% in the last two years (Zanoni). Hence, it will lead to increased company’s PEG (price-to-earnings growth).

Market share of the company is habitually overlooked while determining the price-to-book ratio of Facebook leading to undervaluation. Facebook has a significant market share that contributes to the value of the company. It accounts for about 73% of the U.S. digital advertising together with Google (Kam). Facebook has extensive data of the users, which makes it have a competitive edge over other companies. The company boasts of over 2 billion users and it continues to increase its monthly active users amount (Kobayashi-Solomon). Moreover, its active users have helped to attract more advertisers leading to revenue growth. In 2017, for example, Facebook achieved a high gross margin of about 85%, which is higher than Google’s gross margin of 62% (Zanoni). It shows that Facebook has a higher potential for further expansion.

Facebook’s average debt-to-equity ratio is low; hence, it should not be underestimated. Moreover, this social network continues to expand its operations by acquiring other entities. Undoubtedly, Facebook has great growth opportunities. For instance, virtual reality has helped the firm to position itself exceptionally after the purchase of Oculus, a leading VR headset-manufacturer, in 2014. It acquired WhatsApp, which increased its net worth. Facebook Messenger as well as WhatsApp, each have over 1 billion users and can be leveraged or monetized with services such as payments, video conferencing, and chatbots among others (Kam). The company’s market value will help the firm to maintain its good performance.

Facebook has sustained a tremendous growth in its PEG ratio and free cash flow. It offers products that are worth billions of dollars and can help the firm to outgrow its valuation. Its current growth rate and mergers/acquisition make the company’s value to be above $150 billion (Kobayashi-Solomon). Instagram has been a pillar to the growth of Facebook. Facebook acquired it in 2012, and it generates additional revenue with an average growth rate of about 30% per year (Zanoni). Admittedly, the social networking service company dominates mobile advertising, and it generated approximately $22.5 billion in 2016 from the industry. Economists predict that its fair value is $169. However, the expansion of the business and its latest growth in the ad industry makes its fair value to be between $175 and $217 (Kobayashi-Solomon). Hence, the estimation of economists still undervalues the business.

Why investors buy government bonds, corporate bonds and offer corporate loans

Investors can buy government bonds due to their liquidity, perceived safety, in addition as a guarantee for the loans. Buying this type of bonds they are assured of getting back their full amount and interest (Omololu). Moreover, these bonds are accepted by banks as security for loans. They are generally liquid in that the national government does not only issue the bonds before repaying the face value and associated interests, but the buyer also can sell it before the maturity. The government bonds can be purchased and sold as well as being traded in the same manner as the public company stocks. Investors will usually purchase government bonds due to their perceived safety (Emanuelson 28). When the bond matures, investors are assured of receiving their principal amount. On the contrary, in case of non-government bonds, one may not be certain of getting the invested amount if a bank that offers high interests becomes bankrupt or gets into financial trouble. Thus, most investors would prefer government bonds due to the perceived safety in spite of the low returns.

Although the risk of not repaying a government bond is relatively small, some risks are present and they are usually centered on interest rate fluctuations, opportunity costs, and increasing prices (Omololu). When there is too much new credit, the economy is bound to experience inflation. However, the principal amount on a government/treasury bond is only assured in nominal amounts. When the economy experiences inflation, the return on principal amount is worth less than the original investment. Additionally, investors that purchase government bonds can encounter an interest rate risk (Omololu). It becomes difficult for investors to liquidate their bonds without losing on an investment. Purchasing of treasury bonds will always carry opportunity costs. For example, the buyer would have been able to buy a different form of security with a higher return or acquire goods that can be valued more highly compared to the yield on the bonds.

Investors buy corporate bonds because of the perceived safety, liquidity, attractive yields, and the possibility to gain a steady income, in addition to meeting their investment objectives. It is safe to purchase corporate bonds because they are evaluated and assigned the ratings based on ability to repay and credit history obligations. Safe investments have higher ratings as determined by the likelihood of repaying the principal and interests (Emanuelson 31). Furthermore, the bond is marketable due to its size and liquidity. Thus, the investors buy corporate bonds due to the possibility of selling them before maturity. The bonds offer attractive yields since the organizations give higher yields compared to mature government bonds (Omololu). Investors are able to increase their net worth from the interests earned from corporate bonds. They often get a steady income while still preserve their principal amount. Hence, the investment generates an extra income for buyers. All in all, the corporate bonds give the investors an opportunity to select from different sectors, structures as well as credit-quality features to meet their investment objectives.

Corporate bond is usually associated with redemption risks, interest rate, liquidity, and credit risks. Interest rate risks can be experienced since their prices increase when interest rates decrease and vice versa. The longer the time it takes a bond to mature, the greater the extent of price volatility would be (Omololu). Moreover, the investors often face redemption risks since the call features of corporate bonds allow the bond issuer to redeem the bond partially or fully before the expected maturity date. Further, credit risks associated with corporate bonds include default and downgrade risks. Defaults may occur when a firm fails to repay the interest or principal amount to the debt holder as agreed or as scheduled in its indenture. Conversely, downgrade risks appear when a rating organization lowers the rating on a bond or the firm that issued corporate bonds. It leads to reduced bond prices that affect investors (Omololu). The bonds also have a liquidity risk, as the high-yield bonds may be less likely to be liquidated compared to investment-grade bonds depending on the market conditions as well as the issuer. Overall, corporate bonds that are high-yield are more vulnerable to economic risks since their prices can fall significantly during economic downturns than the investment-grade bonds.

Corporate loans are the funds offered to the firms by individuals or groups because they want to own a part of the business in addition to earning interests from the loans. The corporate loans can be of different forms, and the lenders may adjust the interest rates based on market conditions and risks involved. The loans allow the companies to have sufficient funding for their business activities (Emanuelson 35). They may include a working capital, real estate, equipment, venture, and line of credit loans. Investors can provide the loans to corporations with the aim of acquiring a part of the company’s shares. Furthermore, the interests obtained from corporate loans are often high since the investors determine them. Most companies use their assets as collateral, which gives a certain confidence to the investors that they will receive their principal amount and interests (Omololu). Nevertheless, investors have to consider the previous and current performance of the business before giving a loan to a company.

Corporate loans are associated with multiple risks such as counterparty credit risks, fraud, troublesome renewals, reputation risks, reduced funds, higher levels of scrutiny, and interest rates. Counterparty risks involve defaulting of loans since the business may be unable to service the loan or the other party will not able to meet the agreed terms and conditions (Omololu). Moreover, the management may misappropriate the loan without achieving its intended purpose. Fraud risk is high in organizations since a few employees may embezzle the funds. It leads to troublesome renewals if the company seeks additional funding from the same lender (Omololu). Moreover, businesses have to pay high-interest rates for the loans. They are forced to take less money that can be repaid within a few months or years due to an increased level of scrutiny in addition to avoiding reputational damage.

In conclusion, Facebook is one of the key players in the online advertising industry. Its stock fair values are relatively higher than the estimates given by economists. Economists over-rely on price-to-earnings ratio and discounted cash flow analysis as the basis for Facebook’s stock valuation, which does not offer an accurate value. Furthermore, Facebook’s market share is high and its PEG ratios, as well as free cash flow, have been increasing steadily. On the other hand, investors purchase government bonds because of their liquidity, perceived safety, in addition to being used to guarantee loans. Corporate bonds may be bought due to perceived safety, liquidity, attractive yields, and investors can gain steady income, in addition to meeting their investment objectives. Conversely, investors can give corporate loans so that they own part of the business or earn interests.