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Valuation leaves Facebook vulnerable

Facebook earnings arrive on 23 April, but the high valuation for the company leaves it open to the possibility of further falls in the share price.

Facebook investors are a hardy bunch. They have to be, for it has not been the easiest of times to be an investor with a long-term view of this company. Earlier this year they must have been feeling very contented, as the share price hit new post-IPO highs. Now, however, the picture looks less rosy, as we shed all the gains made in February and March.

In the last quarter of 2013, Facebook reported revenue of $2.59 billion, an increase of 63% compared with $1.59 billion in Q4 2012. Net income was $780 million, up 83% compared to $426 million for the year-ago quarter, while diluted EPS for the fourth quarter was $0.31, up 82% from $0.17 a year ago. The recent quarter also saw the acquisition of WhatsApp, for the bargain-basement price of $19 billion. In addition, it also snapped up Oculus, which has pioneered the development of more functional virtual reality platforms, for $2 billion.

The big worry for Facebook is its declining user base. Many commentators pointed out how the site is becoming less popular among the young, and the trend of being asked to become friends with your own grandparents on Facebook was a sign that the peak popularity moment had come and gone.

In this environment, then, advertising revenue becomes key, as Facebook looks to make more money from those actually using its service. If you’re like me, you probably just ignore them, but the strategy does seem to be working. Net income in the final quarter of 2013 increased by 20.94% to $514 million, compared to the same period in 2012, mainly due to a growth in advertising income.

High valuations have become the concern in the tech sector recently, as this was what prompted the selloff we have witnessed. Facebook’s price earnings ratio (PE) as of 16 April was 91, compared to the industry average of 37 and the S&P 500’s PE of 18. The company still looks overvalued on this metric. A weak set of results could see us retest the April lows of $55, and this could prompt further losses, with $50.80 marking the low in January.

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