Marko Veckov

Student’s Name Professor’s Name Course Number Date INDIVIDUAL VALUATION REPORT This paper’s aim is to give an evaluation of the value of the specific US company and its stocks. In doing so, recommendation will be given on possible present-day investment in this equity, based on evaluation methods. All the assumptions of the evaluation model will be adequately accessed, as well as recent key events that may influence the decision to buy, sell or hold this company’s stocks. Paper hypothesize that decision to buy, sell or hold company’s stocks is not only influenced by its current financial results, but also by announced events in the forthcoming future. Overview of the company History of Facebook is that of great and revolutionary success, which didn’t just impact tech industry but people’s everyday lives all around the world. On 4 February 2004 the Web service thefacebook.com opened for students at Harvard University in Cambridge, Massachusetts[CITATION Bru15 \p 2 \l 1033 ]. The site initially served students’ communities at Harvard, Stanford, Yale and other northeastern prestigious universities. The main features of the site were personal profile of the users and a network. Profile was visible to the members of the network if privacy settings allowed that. User was connected to a social network of other users, but he could choose, which one of them would be linked to his or her profile, thorough ‘friends’ option. Although initially a tool for the few, in its second phase of development from 2006 until 2008, the number of its users and its international relevance grew. In its third phase of development, despite still providing mostly an empty structure, where most of the content was provided by users, its base grew up to 500 million users in July 2010. In 2012, company decided to go public and its chances of successful IPO were very high. There are very few companies in history that have had this high a profit margin (Google being one of them) [ CITATION Mil141 \l 1033 ]. Prior to the event of selling stocks, company was nearing a billion users and almost half of the number of total Internet users. Executive summary Facebook is the largest social media platform in the world. Despite difficulties in calculating its fair stock value, due to unavailability of future dividends, other parameters like P/E ratio can be used to access this investment. For example, current P/E ratio tells us, how big is the difference between its current price and its annual earnings. Although global pandemic had impacted economies and businesses around the world, company seem resilient to its spread, which even gave a push to its usage, as more and more people were staying home. Not even the announced anti-trust campaign, which will only intensify if Democrats win 2020 election, managed to diminish company’s reputation. This year’s second quarter earnings, which were above other competitors and 11 % above last year ones, proved this. On August the 6th Facebook’s stock was announced as the stock of the day, caused by its further earnings rally. This was only fueled by the decision of White House to ban TikTok, one of its main competitors. Company’s earnings report for Q3 is expected to slide down measured on per share basis, while revenue is expected to grow. However, just like with many other tech companies, its earnings and revenue are expected to bounce back after the economy recovers from pandemic in 2021. Company has proved more than resilient during the pandemic and currently it is fifth largest company on S&P 500 list. However, announced regulatory changes and anti-trust laws are possibly delaying the decision to but its stock right now for some near future period. Long awaited entrance into anti-trust territory, where company is expected to be questioned over its acquisitions of Instagram and WhatsApp is just making this decision more complex. Currently, it is not recommended to buy its stock, but the company is moving to an area, where buy signal will be actual again. Industry/Macro/Competitive Analysis In the year of 2013, social networking sites like Facebook, were recognized as a new great wave in technology. They were viewed as a great way of connecting people with similar interests, who have included these sites into their everyday practice. Facebook had over 800 million users and 50 % of Facebook’s active users checked their Facebook accounts on any given day [ CITATION Man13 \l 1033 ]. Not only did the company established itself as most popular social networking site, but it become a useful tool when it comes to brand communication and customer relationship management. The site serves as a window to an ultimate human experience on product usage, later shared with closest friends, members of personal network. It wasn’t just retailers who realized the importance of establishing presence on the network, but also restaurant owners, who created their fan pages. Many people in restaurant industry realized that creation of fan pages is yet another way of communicating with consumers. Over the years, Facebook has become a useful tool for people engaged in marketing activities to promote their businesses. In the past, they used TV, radio and print media to reach potential consumers, but these days social media have risen to the position of most desired advertising tool, due to its data-storage technology. The use of social networking sites is growing continuously and has become part of daily activities for every customer [CITATION Hus20 \p 538 \l 1033 ]. Facebook became effective in transferring images of brands from companies to the consumers. Primary tool for achieving higher sales of the advertising companies is to raise awareness about its products on company’s main platform. Economically, usage for marketing goals is a prevailing trend among social networking sites, which provides them with highest revenue percentage. Socially, demographic characteristics of Facebook users are another element of macro analysis of this industry. Legally, regulation policies regarding data which Facebook gathers about its users is currently regulated in a not too restrained way. Politically, the impact of Facebook users’ posts on the events like the elections, can have a profound influence on the direction and outcomes of the election. Finally, technologically, Facebook faces fierce competition of newer similar platforms like Snapchat, who tend to attract more younger audience, and along the way becoming preferred way of peer communication for them. Valuation methods When an investor purchases, the stock of a company, his willingness to pay certain price depends on what he/she expects from it in the future in the form of dividends and capital appreciation or depreciation. Here the price of the stock is taken as its intrinsic value, under assumption that all relevant information, which could influence its determination are known. The stock’s intrinsic value based on DDM can be calculated using equation: where DPS denotes expected dividends per share at the end of period t [CITATION Bak20 \p 150 \l 1033 ]. DDM stands for dividend discount model and k in the equation is expected rate of return at the end of period t. Therefore, for calculating value per share of the common stock, we must know required rate of return and expected dividends per share. Required rate of return depends on investor’s ability to take risk and can be calculated using various pricing models. Predictions about dividends are very unthankful especially for a longer period and therefore certain estimations need to be made. Based on these predictions, two versions of this model were developed, one where growth of dividends is constant and the other with changing growth. Model of constant growth or Gordon model assumes that dividends grow at a constant rate. The equation is as follows: where DPS0 is the last dividend per share that is paid, DPS1 next dividend per share, k t cost of equity and g growth rate of dividends. Growth rate of the company can be calculated by multiplying return on equity with retention ratio, which shows the percentage of net earnings that are not distributed as dividends. Above mentioned formula can be used also in the case of decreasing dividends. Where dividends change at constant rate, formula is more simplified and that is in most cases the example of mature companies, which reached steady pace of growth. Usually, growth rate in this model is equal or less than growth rate of the economy, calculated as percentage change of country’s GDP. If this growth rate is higher, it is likely to decrease after the company grows and matures. For the model to work, growth rate must be less than the cost of equity. For many companies, predictions of the future growth rate cannot be simply made, as its pace is changeable due to life cycles of these companies. Multistage valuation model uses a terminal value to calculate present value of future cash flows in the form of dividends for estimating fair stock value today. A very common approach is to use a higher growth rate for a five to ten-year period, and then a smaller growth thereafter as the firm reaches a more mature phase [CITATION Hol18 \p 1 \l 1033 ]. This shift to smaller growth rate, usually increases cash flow of the company. Also, it comes under the assumption that young firms have typically high growth rate and with maturity over time, this rate tend to stabilize at a lower level. Young firm at their early stage need more cash to finance that growth, while mature firms need the amount that exceeds the one necessary for everyday operations. With mature firms, total current non-cash assets cover total current liabilities. This is exactly the reason why it is expected from mature firms to generate higher dividends. Therefore, it is more likely that retention rate will decrease as the firm reaches maturity. With this valuation model, all necessary components for calculating stock value like operating profit and growth rate must remain in the same accounting relationship as the firm shifts from one rate to the other. Limitations of valuation methods The main limitations of these models are the hardships of their applications when various data are not available. Currently, there are no disclosed information regarding future dividend policy of Facebook, knowing that the company didn’t pay dividends in 2019 and 2020. Further, all valuation models start with the idea that the value of an investment is based on the cash flows it is expected to deliver [CITATION Jon15 \p 237 \l 1033 ]. This idea is tied to the notion of consumption, and cash is an item that enables consumption. Investment is nothing more, bit the deferred current consumption aimed at buying future consumption. The value of the investment is, therefore, present value of the cash it is expected to deliver. If there is a risk that this cash value won’t be delivered, this expectation must be discounted for this possibility. Therefore, according to all these evaluation methods, value of the stock is present or discounted future cash flow in the form of dividends, which the stock will generate in the future. This places the valuation approach, in the same line of rationalist thinking as neo-classical economy. Therefore, the same criticism approach can be implemented here. This implies that consumption as an end goal of investment can be questioned, as the sole goal of this activity. In recent times, behavioral economists expanded this approach by claiming that other factors influence trading practices and that they may not align with rational expectations. In dividend discount model valuation is based on predictions of expected dividends. In times of impossible forecast of future dividends, this aspect of the model becomes irrelevant. Therefore, another model with infinite time horizon is implemented instead. However, this model preserves the notion that the value of the stock is calculated by discounted cash flow of future dividends, this time only with infinite horizon period. Key events in the nearby future As of April 2020, Facebook has 2.6 billion users, but for any decision in investing in it, several changes in its environment need to be accessed. At first, there are possible changes in its regulatory environment and user landscape, which make its demise if not obvious than less unobvious in the long run. Indeed, the closure of an online social network would not in itself be unprecedented [ CITATION Ohm20 \l 1033 ]. In the past, this thing happened to social networking platforms like Myspace and Friendster. Facebook seems to be more resilient to the shift in user landscape than these sites. Some of them, however, continued to have users, even after they were shut down or sold. Main threats to company’s current position are changes in user’s demographic profile and preferences, as well as growing competition from new platforms like Snapchat. It was evident on the example of Friendster, that while company may lose core of its users in one region it could gain support in the other area. In many areas of the world, there are initiatives for tighter regulations on social media platforms, which tackle Facebook, and which if implemented will distract the company from the ability to gather user data easily. This could reduce the value of the platform for advertisers, who currently rely on its gathered data for profiling consumer behavior. Advertising generated approximately 98.5 % of total Facebook’s revenue, where vast majority of it happens on its main platform. Also, in several countries company might become a subject of anti-trust laws, which may impact its acquisition of Instagram and WhatsApp and influence future growth. User preferences are slowly shifting towards mobile apps, when it comes to social media access. In this field, apps like TikTok and Snapchat have slight advantage. Despite still being most visited social media platform, when it comes to time spend on it, it started to lose this position in 2015 in favor of Snapchat. Another event in the atmosphere of coming US elections that could influence the decision to invest in the company’s stock are announced ‘antitrust’ measures aimed directly at Facebook. These measures are announced at the time when Facebook’s growing political influence cannot be denied by the company’s leaders anymore. It was a “crazy idea” Mark Zuckerberg declared in the aftermath of the 2016 US presidential election, that fake news on Facebook had any influence over the result [ CITATION Mur20 \l 1033 ]. However, after 12 months, company’s founder had to apologize to the public following the revelation that Russia used the platform to spread false news about the election. Four years afterward, company is trying to prove that their steps of casting out any misinformation on its platform is giving results. Facebook’s success at this, or its failure may influence that way in which the regulators will tackle this giant of technological industry, but also the entire industry. Currently, company is very cautious in its handling of this matter, fearing it could face harsh comments from Republican candidate, current President Donald Trump. He has already taken steps to exclude the tech giant from its immunity, which was allowed to them for the user content they present on their platform. He is not their only concern, however, as the company is trying to pay attention to his rival as well, Mr. Joe Biden, who have announced more strict anti-trust laws if he wins the election. This time, company is not only battling with Russian interference, but also with domestic malicious comments. Despite this, the platform was frequently used by both candidates and their supporters in the months prior to the November 3rd election. Mr. Trump has used the platform to complain about the possibility of postal voting fraud and advised his supporters to monitor polling places. Facebook has responded to these claims by implementing a place on its platform, where users can show facts about the voting process. Also, company has adopted new anti-hate speech policy for restricting such content in the months before the elections. Many fear that if current President refuses to admit the defeat on the election, that the platform will become a tool of mass protests or interference and that it will respond when the problem arises. Over the past years, Facebook has become main source of news consumption for its large user base. It has largely put newspapers, especially local ones into lower positions, when it comes to media relevance. Company is often accused in favorizing specific media content, like rightwing posts by prominent conservative figures, like Mr. Trump himself. On the other hand, they are refusing to disclose any internal data. Company’s founder is expected to witness in front of Congress over changes of the 1996 law that grants them immunity over content they publish at their platforms. Democrats have also announced changes of the 1996 law and tougher privacy and anti-trust laws. Meanwhile, company insists on it being apolitical and where decisions are made with reference to the right of “free speech”. Conclusion Facebook is by far the most important social networking site of the past decade. However, at the start of the new one, it is facing significant environmental changes that can influence its business doing. They mostly come from the legal area, where both candidates on current Presidential election are advocating for tighter regulations in the anti-trust area. Also, both sides are advocating for changes of 1996 law, which enabled companies like these to be excluded from any repercussions regarding content they publish. Besides changes in legal environment, changes are possible in social one as well, as demographic profile of their users might change in not too distant future. This was something that happened to similar platforms, like Friendster, who experienced shifts in regional usage in certain areas. Finally, mixture of economic, technological and political aspect of its environment can also have a profound influence on its business conduct. Other tech companies, like Snapchat are drawing large, mostly young audience. Facebook’s influence on political events, like US elections cannot be underestimated, as single provocative post from any of the candidates can impact the companies that advertise on its platform. All these events can impact the company’s advertising revenues, which are the largest part of their annual earnings. Despite company’s resilience during COVID pandemic, all these announced events make the decision to buy its stock more unsecure. It is certainly expected that Facebook’s stocks will rebound after the pandemic’s end. However, company is currently in the area where any decision to buy its stocks should be delayed. Works Cited Baker, H. Kent, Greg Filbeck and Halil Kiymaz. Equity Markets, Valuation and Analysis. John Wiley & Sons, 2020. 29 October 2020. . Brugger, Niels. "A brief history of Facebook as a media text: The devlopment of an empty structure." Peer-Reviewed Journal on the Internet 20.5 (2015). 29 October 2020. . Holland, Larry C. "Calculating a Consistent Terminal Value in Multistage Valuation Models." Accounting and Finance Research 7.1 (2018). 29 October 2020. . Hussain, Iftikhar, Imrab Shaheen and Aneeqa Afaq. "Linking Customers' Purchase Intentions and Facebook Applications through SEM Analysis." Pakistan Social Sciences Review 4.2 (2020):- October 2020. . Jones, Stewart. The Routledge Companion to Financial Accounting Theory. Routledge, 2015. 30 October 2020. . Manthiou, Alkaterini, Lanlung Chiang and Liang Tang. "Identifying and Responding to Customer Needs on Facebook Fan Pages." The International Journal of Technology and Human Interaction (2013): 17. 29 October 2020. . Miller, Nancy. The Facebook IPO Primer. eWallstreeter, 2014. 29 October 2020. . Murphy, Hannah. "US election: Facebook's political balancing act." Financial Times (2020). 30 October 2020. . Ohman, Carl and Nikkita Agrawal. "What if Facebook goes down? Ethical and legal considerations for the demise of big tech." Journal of Internet Regulation 9.3 (2020). 29 October 2020. .