LET'S BE CLEAR: Facebook Is A Great Company -- It's The Market's Expectations That Were Ridiculous

Mark Zuckerberg 97Mr Long Term.

Photo: ceoworld.biz

Facebook’s stock crashed to new lows this morning after the company’s first earnings report since going public in May.Why?

Because the results were merely in line with the guidance the company gave analysts prior to the IPO.

And because the company announced that it would be radically increasing its rate of investment in the second half of this year, which will hurt its profit margin.

From a long-term value-creation perspective, this increased rate of investment is smart. The value of a company (and stock) is the “present value of future cash flows,” and if Facebook can increase its cash flows in 2014 and beyond by investing heavily now, investing is exactly the right thing to do.

Of course, there’s no guarantee that Facebook will get a big return on its heavy current investment, and Wall Street is notoriously impatient.

So the combination of decelerating revenue growth, accelerating investment, and no corresponding benefit to revenue has sent many investors running for the hills.

Importantly, however, Facebook is doing exactly what it said it would do¬†before it went public–emphasise the long-term at the expense of the short-term. Mark Zuckerberg said clearly in the company’s IPO prospectus that Facebook does not make products to make money… it makes money to make products.

So Facebook’s decision here should not come as any sort of a surprise.

But, somehow, it has.

Somehow, millions of investors convinced themselves that the Facebook IPO was the closest thing they would ever get to a sure thing and that price didn’t matter. After all, everyone seemed to agree, Facebook was “the next Google.” And no one wanted to miss out on that.

Well, long before the IPO, there were a lot of signs that Facebook was not, in fact, the next Google. And the stock went public at a valuation that was extreme by any measure–more than 80X last year’s earnings. And it went public at this valuation despite sharply decelerating revenue, a profit margin that was already extremely high (suggesting that it only had one way to go–down), concerns about the effectiveness of its ad units, and a CEO who made crystal clear what his priorities were.

In other words, it went public in a market in which expectations about the company’s likely performance were completely out of whack.

Well, those expectations are now gradually, painfully coming in line with reality.

And that’s never a happy process. It’s much easier for companies to look great and be loved when they’re also making investors boatloads of money.

But the declining stock price should not for one second make anyone think Facebook is doing the wrong thing.

On the contrary… Facebook is doing exactly the right thing.

Unlike most companies, Facebook is tuning out the short-term pressures of Wall Street and focusing on the long term. It is investing aggressively in the future, at the expense of the present.

And, in so doing, it is acting exactly the way one of the other great tech companies has acted for years: Amazon.

Now that Amazon is, once again, a stock-market darling, it’s easy to forget the 7-8 years when it was anything but.

For years after the dotcom bust, Amazon invested aggressively…while its stock treaded water.

For years, analysts howled that Amazon’s Jeff Bezos wasn’t making enough money.

For years, Jeff Bezos ignored them.

And now Amazon is AMAZON… the global ecommerce juggernaut.

And Amazon’s stock price is once again doing great.

Prior to Facebook’s IPO, Mark Zuckerberg told Wall Street exactly how he was going to run his company. Many investors didn’t listen… and now many investors are paying the price.

At some point, however, investor expectations will finally come in line with the Facebook reality.*

And when they finally do, long-term Facebook investors are likely to (finally) be in for a great ride.

SEE ALSO: Facebook’s Quarter In Charts

* What is that reality? A couple of months ago, I estimated that a “fair value” for Facebook’s stock was about $16-$24 a share. I don’t think that’s changed much. And we’re finally in that range.

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