By David Weidner, MarketWatch
SAN FRANCISCO (MarketWatch) — Do you use Facebook to keep tabs on your friends, family and the latest entertainment and news?
Well, there’s more. Facebook Inc.’s (NASDAQ:FB) stock is also useful. Not only can it tell you whether the social media site is overvalued, it hints at the same over-exuberance in the broader stock market.
And guess what? What it’s saying now ain’t pretty.
On Friday, Facebook shares rose to close at $38.05. In doing so, the company enjoyed its first day of trading above its initial offering price. Yes, Facebook’s 440 days in the wilderness are over.
Why the rise? Well, long-suffering investors will probably point to the company’s most recent earnings. Facebook reported a profit of $333 million on July 24. The results beat analyst expectations and surprised investors because close to a third of the company’s $1.8 billion in revenue came from its mobile platform — a cash stream that basically was nonexistent a year ago.
It was a relatively impressive quarter. And investors responded. Shares are up 53% in the last 30 days — yes, fifty-three percent.
So, what’s not to like? I’ll let you judge. For one, Facebook’s forward price-to-earnings ratio is 41. By contrast Google Inc.’s (NASDAQ:GOOG) is just 18. Facebook’s trailing P/E ratio is 177. Facebook is valued at $95 billion — nearly twice the value of Hewlett-Packard Co. (NYSE:HPQ) and three times the value of Yahoo Inc. (NASDAQ:YHOO) .
All of this euphoria, it seems, is based on one measly quarter. Here’s Facebook’s income for the last four quarters until this one: $217 million profit, $43 million profit, $38 million loss , $157 million loss.
/quotes/zigman/3870025 SPX 1,695.50, -11.64, -0.68%
There are two ways to read that: Facebook is doing great, it’s showing rapid profit growth, or Facebook has made roughly $400 million during the last five quarters. Its return on equity is 4.3% (Yahoo’s ROE is 33.6%).
Investors are clearly going with assessment No. 1. And why not? The profit trend is encouraging. The trouble is that Facebook’s high valuation is a bet that ignores an problematic underlying trend: its user growth is slowing. Facebook is still adding users, but its number of inactive accounts must be causing deep concern at the company.
In other words, Facebook is doing a better job of mining its existing customer base, but that base may be headed toward saturation.
So, how does this reflect the broader market? I’d argue Facebook is indicative of market trends in many ways.
Like Facebook, the S&P 500 (SNC:SPX) (SNC:SPX) is historically high. Its P/E ratio is 19.5. Compared to a historic mean of 15.5 and median of 14.5. It’s close to the P/E ratio of some notable bull markets about to bust. The index’s ratio was 21.46 at the start of 2008 (the housing bubble). It was 27.6 at the start of 2001 (the tech bubble). It was at 18 at the beginning of 1987 (before the crash).
Secondly, like Facebook, there are some problematic underlying trends with the broader market. July unemployment was 7.4%. Gross domestic product grew at just a seasonally adjusted annual rate of 1.7% during the second quarter. The S&P Case-Shiller Index is still down 1.34% on an annual basis compared to five years ago.
Yet, the market churns on. The index is up 27% since mid-November, or just 35 weeks.
Meh earnings? Who cares!
Paul Vigna and Steven Russolillo discuss the lackluster response to earnings season, and Jack Nicas looks at JetBlue's upscale move. Photo: Getty Images.
You get the point. Even if the market historically recovers before the broader economy, like Facebook’s ascent, investors seem to be missing some sobering news in the fundamentals. They’ve bought too much, too fast on some big expectations and little underlying substance.
Moreover, just as Facebook has pinned some of its future on international growth, what’s happening in China, Japan and Europe suggest those markets aren’t going to lift U.S. industries in any meaningful way.
This isn’t to say that these bets have been flat-out wrong. It’s just that there aren’t any sure things in the market, even when all of the evidence points to unbridled growth and profits. If you don’t believe me, see 2007.
In addition, there is a final link between the broader market and Facebook. Online ad spending was up 16% to a record $9.6 billion in the first quarter, according to the Interactive Advertising Bureau. Online ads are becoming more essential to companies, but they still are part of the budget that is first to be cut when clouds appear.
That means Facebook could run into trouble should what little growth there is stalls.
Ultimately, investors should see Facebook’s stock price turnaround for what it is: a reflection of the company’s ability to squeeze more pennies from its existing customer base. That’s a good thing. But at some point Facebook and U.S. corporations are going to need more customers with more pennies.
That’s the missing bit of information that needs to be shared.
