How Doing Your 'Share' Has Enriched Facebook

There are several – if not many – companies that have over a billion clients. Drink the world’s most popular soda or smoke its most popular cigarettes, and boom, you’re part of the customer base. But imagine a company with 1.2 billion registered users (give or take an Egypt or Germany’s worth of fake ones), many of them using its product for hours on end and cavalierly conveying their personal information while they’re at it. Founded in 2004, Menlo Park, Calif.-based Facebook (FB) is new enough that you’re probably familiar with its history. If not, here’s the one-sentence version: College kid notices how ugly MySpace is, makes something sleeker and markets it to post-adolescents. The phenomenon of Facebook, and the speed at which users joined and continue to join, is unprecedented. But just because a novelty is adopted by a large chunk of humanity, does that mean it’s inherently an economic powerhouse?

From Frothy to Flat, and to Frothy Again

If you believe that an overvalued juggernaut shouldn’t take more than two years to reenter the atmosphere, then the answer is most likely yes. Facebook stock lost half its value within three months of going public in May 2012, only to quadruple in value from that nadir. The stock still sits at close to an all-time high, resulting in a company with a market capitalization of $160 billion. That large number is the result of anticipation that Facebook will one day realize growth beyond its current apparent capacity. The company’s book value sits at a considerably less remarkable $15 billion, which is still substantial for an entity that didn’t even exist a decade ago and which doesn’t exactly provide an indispensable good or service.

Facebook's Real Users

Last year Facebook turned a profit of $1.5 billion on revenues of just under $8 billion, an enviable profit margin regardless of market sector. But unlike the company’s cohorts on the list of the world’s largest, Facebook doesn’t sell directly to customers. Tempting though it might be to collect even a nominal fee from each of those 1.2 billion users, the company charges them nothing to use the site. Instead, as you presumably know if you’re one of those 1.2 billion, Facebook’s true customers are advertisers. Some of the world’s largest purchasers of advertising, such as AT&T (T) and General Motors Co. (GM), have Facebook pages whose “likes” number in the millions. 

But large corporations are only part of Facebook’s true clientele. The company’s advertisers range from multinational oil refiners to neighborhood craft stores, each convinced that reaching potential customers by spending money on the world’s largest social media site is mandatory, not optional.

Rise of Mobile

As use of mobile devices has increased relative to desktop computers in recent years, Facebook and its advertising have followed suit. 2013 represented a watershed year in that for the first time, most of the company’s money came from smartphone/tablet advertising. That’s not the result of a small sample size, either. 2013 was also the year in which Facebook welcomed its millionth advertiser, confirming the truth that online advertising has left its legacy media brethren of print, radio and television behind, probably forever. 

Facebook might be a glorified coupon book, a constantly updated one on which you can post your vacation photos and wait for your friends and friend equivalents to leave banal comments, but there’s more to the company’s revenue streams than just advertising. Somewhat surprisingly, Facebook derives a lower percentage of its revenue from advertising than does its competitor in documenting every detail of its users’ lives, Google Inc. (GOOG). In fact, in its short existence Facebook has gone from exclusively dependent on advertising to operating a model in which 10% of revenue comes from payments. That most likely means via games. Play Candy Crush Saga or some other video game, buy 99 cents worth of additional gameplay, hundreds of times over, and not only have you thrown away enough money to buy a few shares of Facebook, but you’ve contributed to the company’s prospering secondary revenue source. Multiply by tens or hundreds of millions of users, and you get the idea.

The Bottom Line

A generation ago, the idea of a virtual meeting place for people of common interests to congregate was conceivable, if not necessarily practicable. The idea of monetizing such a place was even further removed from common understanding. As for monetizing it to the tune of tens of billions, buttressed by a population eager to spend money on non-physical trinkets and be advertised to continuously…well, that’s what makes Facebook’s rise so remarkable, and the company itself so distinctive a player among the world’s largest and most successful.

4 Things to Look for in an Investment

New investors are often interested in purchasing a company's stock but are not sure where to begin. These four characteristics should serve as helpful guidelines in your search for a good investment.

1. What is the price of the entire company?

When doing research, it is important that you look at more than just the current share price - you need to look at the price of the entire company. The "cost" of acquiring the entire corporation is called market capitalization (or market cap for short) and is frequently referred to by financial professionals. In short, the market cap is the price of all outstanding shares of common stock multiplied by the quoted price per share at any given moment in time. A business with one million shares outstanding and a stock price of $50 per share would have a market cap of $50 million.

This market capitalization test can help keep you from overpaying for a stock. Consider the case of eBay and General Motors during the heyday of the Internet era. At one point during the boom, eBay had the same market cap as the entire General Motors Corporation. To put that into perspective, in fiscal 2000, General Motors made $3.96 billion dollars in profit, while eBay made only $48.3 million (not including stock option expense!). Yet were you to buy either one, you would have had to pay the same amount. It is almost unbelievable that any sane investor would pay the same price for both companies but the general public was seduced by visions of quick profits and easy cash.

Another useful tool to help gauge the relative cost of a stock is the price to earnings ratio (or p/e ratio for short). It provides a valuable standard of comparison for alternative investment opportunities.

2. Is the company buying back shares?

One of the most important keys to investing is that overall corporate growth is not as important as per-share growth. A company could have the same profit, sales, and revenue for five consecutive years, but create large returns for investors by reducing the total number of outstanding shares.

To put it into simpler terms, think of your investment like a large pizza. Each slice represents one share of stock. Would you rather have part of a pizza that was cut into ten slices or one that was cut into eight slices? The pizza that was only cut into eight parts will have bigger slices with more cheese and toppings.

The same principle is true in business. A shareholder should desire a management that has an active policy of reducing the number of outstanding shares if alternative uses of capital are not as attractive, thus making each investor's stake in the company bigger. When the corporate "pie" is cut into fewer pieces, each share represents a greater percentage ownership in the profits and assets of the business. Tragically, many managements focus on domain building rather than increasing the wealth of shareholders.

3. What are your reasons for investing in the company?

Before you purchase stock in a company, you need to ask yourself why you are interested in investing in that particular opportunity. It is dangerous to fall inlove with a corporation and buy it solely because you feel fondly for its products or people - after all, the best company in the world is a lousy investment if you pay too much for it.

Make sure the fundamentals of the company (current price, profits, good management, etc.) are the only reason you are investing. Anything else is based on your emotions; this leads to speculation rather than intelligent investing. You have to remove your feelings from the equation and select your investments based on the cold, hard data. This requires patience and the willingness to walk away from a potential stock position if it does not appear to be fairly or undervalued.

4. Are you willing to own the stock for the next ten years?

If you aren't willing to buy shares in a company and forget about them for the next ten years, you really have no business owning those shares at all. The simple but painful truth of this is evident on Wall Street every day. Professional money managers attempt to beat the Dow Jones Industrial Average, which is a collection of 30 largely unmanaged stocks. Year after year, they fail to do this. It seems impossible that a portfolio managed by the best minds in finance can't beat an unmanaged portfolio of long-term stocks held indefinitely.

The guaranteed way to success has historically been to select a great company, pay as little as possible for the initial stake, begin a dollar cost averaging program, reinvest the dividendsand leave the position alone for several decades.

Investment Research 101 -- Turning Ideas into Profit

If you have ever wanted to know how to invest in stock, the best place to start is doing your own research. For new investors, this can be daunting. Fortunately, there are a few good places to start. I'll walk you through them.

Public vs. Private

Before one can invest in a business, he must discover if it is public or private. A publicly traded company is one which has shares of stock traded on the open market. Private companies, on the other hand, do not have shares available for public purchase. Private companies may be owned by an individual, a family, a partnership, employees, or a small group of investors.

To illustrate the difference, consider Hershey and Mars, two of the largest candy companies in the world. The late Milton Hershey’s chocolate business is publicly traded on the New York Stock Exchange. An individual investor could take his paycheck and acquire shares in the company, profiting from every Hershey bar or Reese’s peanut butter cup sold. The multi-billion dollar Mars company, however, is still owned by the Mars family. An investor could not buy shares unless the members of the family allowed him to acquire some of their closely held, personal stock.

How does one determine if a company is public or private? The simplest, most effective way to answer this question is to call the company and ask. At the same time, many corporate web sites offer information on their ownership status; rest assured, if you see an “investor relations” section, the company is public. The lack of such a section does not necessarily mean anything. Take, for example, Fruit of the Loom. The undergarment manufacturer is not publicly traded because it is owned by Berkshire Hathaway, Inc. Berkshire, on the other hand, is traded on the New York Stock Exchange. Hence, an investor may be able to indirectly invest in a business entity through a publicly traded parent company.

Ticker Symbol

Once the investor has discovered a company is publicly traded, he must look up the company’s ticker symbol. A ticker symbol is a collection of letters that represent a particular stock on an exchange or the over-the-counter market. Microsoft, for example, is MSFT. Cisco Systems is CSCO. Berkshire Hathaway has two ticker symbols, one for its class A shares (BRKA) and one of the class B shares (BRKB). Coca-Cola is KO. The Washington Post is WPO.

To discover a company’s ticker symbol, the investor can call his broker or go to a site such asYahoo Finance. Once at the main page, he can choose the “symbol lookup” option. The resulting page will allow him to enter the company (or parent company in the case of a subsidiary such as Fruit of the Loom) name.

With the ticker symbol in hand, the investor can return to the main Yahoo Finance page and enter it. After pressing the “get quote” button, he will be taken to a summary page that includes a current quote for one share of the company’s stock, the total market capitalization of the business, recent dividend payment and yield information, the price-to-earnings ratio for the trailing twelve months and other items of interest.

Obtaining Annual Reports, SEC Filings and other Financial Documents

Assuming the figures presented seem promising to the investor, he will most likely wish to acquire a copy of the company’s annual report, proxy statement and 10k. For this, he will find the Internet an excellent source of free, timely information. One of the best resources is Free Edgar, a database of annual reports and SEC filings. Additionally, the investor could contact the shareholder relations department of the company in which he is interested via telephone or web site and request information. The bottom line: Nearly everything you need to know can be found in the annual report, proxy statement, and 10K.

Dividend Reinvestment Programs (DRIPs) and Direct Stock Purchase Plans

If, after careful analysis of the financial statements and business economics, the investor wishes to build up a long-term holding in the company, he may want to consider an automaticdividend reinvestment program and / or a direct stock purchase plan. Both of these are ideal solutions if he desires to begin a dollar cost averaging program into the company; the former will automatically invest his dividends into additional shares of stock while the latter will provide for regularly scheduled deductions from his checking or savings account to purchase shares of the company’s stock without the aid of a broker. Equiserve is a free database containing information on the both types of programs at thousands of publicly traded companies across the United States.