1. Decide how much risk Facebook has compared to alternative investments in the market.
2. How much return do investments with comparable risk have?
3. How much money will Facebook return to its investors over its lifetime, discounted by the rate of return you can get with comparable investments compounded by that many years.
Let's assume Facebook has same risk as Google.[1]
If you bought GOOG at 2004 for $100 and sold it today at $580, you got roughly 26% return year on year.
When will Facebook begin returning money to its investors? Assume 1 years from now they will have more than doubled their profits and begin paying $2 billion a year in dividends, growing by 20% per year from there, forever.(so 2013: 2B, 2014: 2.4B, 2015: 2.88B) [2]
So let's substitute all these numbers into this financial formula I learned last week to find how much Facebook is worth[3]:
Value = (2 billion) / (0.26-0.2) = 33 billion dollars.
As 33 Billion is < 100 Billion, a conclusion is made where Facebook is deemed to be overvalue and its stock should be sold and invested into Google instead.
[1] Remember, we're assuming Facebook has as low a risk(volatility in dividend payment) as Google. For a much younger company like Facebook this is incredibly unlikely. So a discount rate of only 26% is incredibly generous, it should be even higher.
[2] Yes I know Facebook profit increased by 100% last year, but it is still only $1 billion dollars and unlikely to grow forever. Also, paying dividend could be substituted with share buybacks and the result is the same, money is returned to shareholders.
[3] This formula is called "Gordon's growth model" and is a formula learned by second year university students studying finance.
People have been buzzing over a Facebook IPO for at least a year now, so when the moment comes you bet it will be a highly publicized event. Pre-IPO investing is already risky to begin with, and I have a feeling that all this media frenzy may make Facebook's stock unnecessarily volatile at the start.
Sure, the people buying in now may get lucky and see the stock rise in value, but it's also possible that this IPO may just turn out to be another Groupon. Although I'm still in my 20's, I'm not much of a risk taker when it comes to personal investments. Sorry, but I'll pass for now.
Of course it will be when your buying options contracts or day trading, adding Facebook to a long term portfolio is a strong move.
My main belief in Facebook stock comes from the fact Facebook is the company being built on top of at the minute, the ecosystem for Facebook is super strong.
They just need to figure out how to monetize mobile.
It's going to be an industry leader and there will be strong demand from money managers which one would imagine will only lead for a strong buy sentiment.