Peer comparison
Facebook currently trades at a price-to-sales ratio of 11.4, which is pretty high for a technology stock. The upside to owning the stock is potential improvements in profitability. The company currently operates at a 15% profit margin. The company could potentially generate a profit margin of around 30% (similar to Yahoo! or Microsoft Corporation (NASDAQ:MSFT)), while growing revenue to $8.5 billion by 2014 (consensus estimate). Assuming a 30% net profit margin on revenue greater than $8.5 billion, you can also assume that net income should be above $2.55 billion. Assuming the company earns $2.55 billion in net income over the next two years, Facebook’s current market capitalization of $63 billion can be justified.
Google’s involvement in mobile advertising is primarily driven by ad sales through its search advertising and Play Store purchases. The growth in these two categories is likely to be sustained, as the total addressable market for smartphones is expected to grow to 1.4 billion devices by 2016, according to IDC.
Google had a difficult quarter in terms of profitability. The company currently generates a net profit margin of 22.89%. This is low compared to the potential profitability of the business. Going forward, I believe management will allow revenue to grow at a faster rate than costs. The company is expected to grow sales by 40.3% for the 2013 fiscal year (this growth is driven by the Android Play Store). The company’s five-year average revenue growth rate is 24.77%.
The desired outcome is that the company converts a larger portion of its future revenue growth into more profit. This way, the company’s 28 price-to-earnings multiple is sustainable. Based on historical trends, Google should be able to generate a larger amount of profit and revenue.
Conclusion
Yahoo’s! growth in earnings seems sustainable because the company has been able to lower operating costs, fetch sizable rates of return from its minority interest in Alibaba, and has pent-up growth potential from mobile advertising (although profit maximization on mobile advertising is likely to be difficult). The company’s recent string of acquisitions may be enough to push it into becoming fully web 3.0 capable. Yahoo! may have the most upside over both the short- and long-term.
Google Inc (NASDAQ:GOOG) had a difficult quarter, but its fundamentals remain largely intact. The search business should be able to sustain growth due to emerging market growth. For now, Google Inc (NASDAQ:GOOG) seems to have the best balance in terms of net profit and sales growth. Facebook comes in third because the company has to manage costs better in order for its current valuation to be justified.
The article Yahoo! Knocks Out Wall Street originally appeared on Fool.com is written by Alexander Cho.
Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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