Byron Capital Markets is out with a good need dose of reality and humor on the Facebook Inc (NASDAQ:FB) IPO. The firm compares the valuation of Facebook to eight other tech giants and shows how absurd the numbers for Facebook are. They challenge readers to use any numbers in a model to justify the valuation.
How Much Earnings Growth Is Needed?
We blow the dust off a tool we developed about 12 years ago in the (last) tech bubble that helped us judge the level of valuation insanity. Basically we use a modified multi-stage DCF to calculate how much earnings growth high flying stocks need to eventually justify their current valuations.
The Concept Is Quite Simple: We use net income as an approximation for cash flow (close enough in the long term) in a multi-step DCF calculation. We then plug in various levels of growth over the next 10 years and a terminal P/E multiple to give us an NPV that is equal to today’s enterprise value. We then sit back and look at those growth rates and say “Ah Shucks, do those there growth rates seem reasonable?”
We Start with Facebook Inc (NASDAQ:FB): But we also apply this to several other names including Google Inc (NASDAQ:GOOG), Amazon.com, Inc. (NASDAQ:AMZN), Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT), QUALCOMM, Inc. (NASDAQ:QCOM) and others. We think the results are quite revealing. Specifically, we calculate:
- Facebook Inc (NASDAQ:FB): Needs to achieve 30% – 40% growth rates in the first few years and maintain 15% – 20% growth for at least 10 years and still be trading at 19x earnings 10 years from now to justify its stock price.
- Contrast This with Google Inc (NASDAQ:GOOG): Only needs to achieve single-digit growth from the next few years and GDP like growth thereafter, as well as only a 13x earnings multiple after 10 years.
- We Also Look at Names Like Apple Inc. (NASDAQ:AAPL), Amazon.com, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT) and Intel Corporation (NASDAQ:INTC) and get some pretty interesting results. Apple looks very reasonable, Amazon.com, Inc. (NASDAQ:AMZN) makes Facebook Inc (NASDAQ:FB) look cheap, and Microsoft Corporation (NASDAQ:MSFT) needs to shrink to justify its valuation! Intel never has to grow again.
- Don’t Like Our Assumptions?: Then use your own assumptions in our DIY version of the model. Let us know and we can ship you the excel model and you can plug in your own growth rate, discount rate, terminal multiple assumptions – for any name you
Growth Rates Needed to Justify Valuations
The following exhibits show our set of assumptions that we used to get our DCF model to give us an NPV equal to the current evaluation. Specifically, we adjust the growth rates for each of the next five years, followed by an average growth rate for years six through 10, and then a P/E ratio we think the stock will be trading at a decade from now to get a NPV that is close to the current EV.
The key thing now is to sit back, scratch our noggins (or wherever) and ask if these growth rates seem reasonable for each of these companies. We won’t pretend to closely follow all these global names, so we will leave most of the judgement up to the reader, but here is our quick head scratch response:
• Possible, but it needs some faith (i.e., a caution signal):
o Facebook – We’d put our new friend Facebook in this category with 40% growth declining to 20% in the next five years, followed by 15% growth and a 19x P/E. To be honest, when we started this exercise we though Facebook Inc (NASDAQ:FB) would have ended in the next category, so I guess this is good news.
• What the..? No Way!: Maybe we better check our calculation again (otherwise hit the panic button):
o Amazon appears to fit this category – but given that this is a well followed name we will just assume we must of missed something or just don’t get it.
• Very Reasonable: It looks like the required growth rates are in-line or below what we would expect the company to achieve (i.e., hang on to these stocks?):
o Google, Apple Inc. (NASDAQ:AAPL), Microsoft, Qualcomm, Oracle Corporation (NASDAQ:ORCL), Intel Corporation (NASDAQ:INTC) – seem to fit this bill. In fact, we think the Google & Apple implied growth rates seem very conservative. And will Microsoft earnings really decline? Intel doesn’t need to grow.
Conclusion – Let Us Know if You Want the Model
This is another tool we hope investors can use to judge valuations. It appears to offer strong opinions on long-term valuations and thus is interesting. However, it’s sensitive to inputs and assumptions and thus we are happy to share it with you if you want to run with your own assumptions.