EC Is Facebook Worth Its Current Price?

All assets are worth the present value of their future cash flows. Even if you haven’t been to business school and heard this financial theory, you probably have some intuitive sense that if you buy a piece of real estate as an investment, you know that the income that property produces relative to the price you’re paying for it is important.

The problem with a “discounted cash flow” approach (forecasting future cash flows and applying a discount rate to them to arrive at a present value) is that people rarely know what future cash flows will be, and nobody knows how to discount them properly to arrive at a present value. Regarding discounting, Warren Buffett likes to apply the rate on the 30-year U.S. Treasury. Others like to apply a discount rate as a “hurdle rate” that reflects the return they’d like the investment to deliver – say, 10%. As Buffett’s sidekick, Charlie Munger, says, valuing an asset isn’t supposed to be easy. And that makes sense since skill at valuation is lucrative.

But instead of estimating cash flows and applying a discount rate to see what an asset is worth, sometimes it can be useful to understand what future cash flows the market is anticipating by awarding a stock its current price. When you back into, or reverse engineer, the future cash flow assumptions the market is making, you can sometimes decide if Mr. Market is off his meds or not.

(Discounting a cash flow is the opposite of compounding it the way you might do a compounded interest calculation. It involves dividing the cash flow by your chosen interest rate for each year in the future the cash flow occurs. So an assumed $100 payment next year discounted at 10% is worth $90 today. An assumed $100 payment in five years is worth $62 today, or $100/(1.1^5).)

So what future cash flows is the current ~$600 billion market capitalization of Facebook anticipating, and are those future cash flows achievable? Let’s try to find out.

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Alexander Straub 1 year ago Member's comment

John, thank you for this indepth look into FB. My primary concern with FB is its user metrics. According to recent numbers, FB's user growth has slowed significantly. This is a major sign of weakness going forward. I suspect this is the result of an accumulation of the more recent events that FB had to deal with. I'm also not impressed with FB's management decisions on content handling.

David J. Williamson 1 year ago Member's comment

While I believe $FB is overvalued, you answered your own question when you wrote:

"Will another platform make inroads into Facebook’s business, or does it benefit from a kind of network effect whereby enough people are already on Facebook that others have to join to be involved in social media?"

Facebook it too big to worry about competition from a new competitor. A social site only works because everyone you know is already on it. The only real contender would have been Google which already tried and failed with Google Plus. If they couldn't make even a dent in Facebook, why would any other company be able to.