Consider the following stock prices (as of June 18, 2012):
Which is the best investment? Which is the worst?
Unless you were living under a rock last month, you’re probably well aware that Facebook went public on the NASDAQ exchange with a crazy amount of fanfare. Did you also notice the “fuzzy math” being used to evaluate the company’s stock price?
During it’s IPO, Facebook was trading at a multiple (P/E ratio) of over 100x. By comparison, similar “rock star” tech companies like Google and Apple typically trade in a P/E range of 14-18x. It’s not our place to recommend whether you buy or short individual stocks, but there seems to be a disconnect here. If Facebook were priced at a similar multiple to Google and Apple, it’s price would be $5, not $30.
Say what you will about the effectiveness of Facebook as an advertising medium — many already have weighed in on that topic (including Facebook). The company fetches the majority of its revenue from advertising. And since it has amassed 900 million “customers” already, the pace of new customer acquisition has slowed considerably at that level, understandably. That means the company needs to significantly increase its average ad revenue per user, to even begin justifying such a high-flying stock price. By a lot.
That’s some serious speculatin’ going on. Warren Buffet might call it “irrational exuberance.” We call it “bad math.”
Okay … what does this have to do with media in general? The P/E multiple in financial markets is analogous to cost per thousand (CPM) in media markets. When you buy something from either industry, it’s probably a good idea to know the respective multiple (P/E or CPM) of the investment before making your decision. Not doing so could be considered wildly speculative.
That’s why media like broadcast television and internet would be rated as good buys. They are priced at highly efficient multiples; the math of growth is in place. Other media, like local cable or direct mail, offer multiples that are 5x to 10x to 50x higher. Advertisers who think they are scooping up a value based on something other than CPM are in for a rude awakening.
Is it possible to buy the market “high” and succeed? Sure, but we’d advise against it. Unless you’re feeling especially lucky … or you have a different definition of “return on investment” than the rest of the world.
Roland Eckstein is the Managing Partner of ESA & Company, an advertising strategy firm based in Red Bank, New Jersey that accelerates profit for local businesses.