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With Facebook IPO, Know What You're Buying

This article is more than 10 years old.

Peter Lynch, former ­manager of the Fidelity Magellan fund, preached to investors to buy what you know. He got his hair trimmed at Supercuts; ergo, he bought shares of Supercuts. Lynch’s philosophy figures in the buzz about the pending Facebook IPO. Safe to say ­almost everyone reading these words has an account or at least knows people who do. (Or maybe you’ve seen the movie.) In a few months the social ­network is going to sell shares to the public for the first time, providing an opportunity to own a slice of what will instantly become one of the world’s most highly valued companies.

Sure is tempting. Facebook, after all, is growing like kudzu. It has 850 million users. In 2011 it generated $3.7 billion in revenue, up 88%, and netted $1 billion. Speculation on The Street has been that Facebook will come public with a $75 billion to $100 billion ­valuation. And I have every confidence that come IPO day, the stock will pop like it’s 1999.

Enjoy the fireworks. But I wouldn’t buy it.

Investing is about choices. If you buy this, you’re not buying that. If you invest in Facebook at a seriously stretched valuation, you are going to be passing up on some far more attractive alternatives.

Assuming Facebook comes public at a $100 billion market cap, the stock will debut at 27 times last year’s revenues and 100 times trailing profits. By either measure, an ethereal valuation.

My advice? Forget Facebook. Buy Apple and Microsoft . Neither company is exactly undiscovered. Apple recently crossed $500 for the first time and is nearing a half-trillion-dollar valuation. Microsoft recently hit the $30 level for the first time since 2010; with a $250 billion valuation, it is the second-most-valuable tech company.

But both stocks are bargains.

Let’s start with Apple. In Q4, while Facebook’s revenue rose 54.7%, Apple’s grew 73.4%. Despite a recent rally Apple’s rapid growth makes it statistically cheap. In calendar 2011 Apple had revenue of $127.8 billion and profits of $33 billion. At $500 it trades at 3.9 times trailing revenue and 15 times trailing profits. Back out the $100 billion it has in cash, and the valuation drops to 3.1 times revenues and 12 times earnings. And there are all kinds of coming catalysts for the stock: new iPhones, new iPads, new Macs, TVs and potentially a big fat dividend. You almost have to own this stock.

Microsoft is cheap, too, at 11 times trailing 12-month earnings, cheaper still if you back out its $57 billion in cash. (Which, by the way, does not include the company’s equity in a certain red-hot social networking company about to come public.) The software giant hasn’t been growing like Apple, but this is going to be a big year for it, with Windows 8 due out soon. This is a major upgrade for the trusty OS--the biggest since Windows 95.


Microsoft is zeroing in on the tablet market, where it has a clear opportunity to take the role of Apple’s chief rival away from Google ’s Android. Talk to people who make PC components about the prospects for the second half, and they are jazzed about the potential for a huge PC-replacement cycle. On the prospects for Windows 8 alone I’d buy Microsoft shares, but there are other goodies on the way as well, including the coming integration of Skype into almost everything Microsoft makes. The prospect has so unnerved Cisco Systems that it has appealed the European Commission’s approval of the Microsoft-Skype deal; Cisco wants ­Microsoft to make Skype interoperable with its own hardware. Seems like a clear sign that Cisco, at least, sees huge potential for the combination.

I’d note, by the way, that both Apple and Microsoft in their own ways benefit from Facebook’s success. Apple has become the world’s premier provider of mobile devices; more and more people are accessing Facebook via their phones--often iPhones. Apple makes money from selling the devices, but Facebook so far doesn’t generate ad dollars from mobile sessions. And ­Microsoft has that 1.6% stake in Facebook, a position that would be worth $1.6 billion at a $100 billion valuation.

While Fidelity’s Lynch was no slouch in the stock-picking game, I’d advise you to know what you buy instead of buying what you know. What I know is this: There is simply no logic to paying 100 times earnings for Facebook when there are far cheaper bets on the future of the digital economy.

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