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Facebook's up-and-down trading since its IPO has polarized investors, but there's a fundamental problem with the company that Mark Hulbert can't ignore.

We are talking about the Facebook phenomena right now with Mark Hulbert. Hi Mark, thanks for being here.

My pleasure.

So Facebook (FB) came out in a big way, and I had all kinds of people asking me should I buy, should I buy? Now, I have never been a big advocate of any IPOs; I like to wait until they come down and then buy in. But the market has not seemed to appreciate what the Nasdaq thought about Facebook to begin with. So what are your feelings today on this stock?

Well, I think if you look at any of the standard evaluation metrics for the stock, it is hard to see how they can justify their current price. They have imbedded in that price incredibly optimistic assumptions about future growth, and even with the earnings report that came out in January, it is not clear that they are growing fast enough.

They are growing fast, don’t get me wrong. Over the last year, I think their revenues have grown 36% or 37%, which is impressive. But it turns out that even if you were to work out the numbers, if you extrapolate that kind of growth rate into the future, they are going to have to do something even more to be able to justify a price in the low $30s, where they are trading right now.

I’m afraid my invitation to my clients is do the numbers yourself. A lot of them don’t like this conclusion from me; they say, "Well, this can’t be right," and I say do the numbers—see if they add up.

I mean, in one of my back-of-the-envelope calculations, I assumed that in five years’ time, it would have the same price-to-sales ratio as Google (GOOG). Well, that is a very optimistic assumption, because Google is trading at something like three times the price-to-sales ratio as the market itself. So even with giving that kind of a generous assumption, what must their sales grow for the next five years in order to justify a price where they are now even faster than what they are doing?

Right, and in terms of most of their revenue is going to come from their advertising, right? How do you grow that? Most people don’t really understand the social media concept and how you actually make money from that.

I don’t know that Facebook understands how you actually make money from that. I mean, they are definitely pulling in revenue. But from my perspective, I have talked to a lot of people that have advertised there, and they have not been happy with the results from that.

Right. I mean, I’ve heard those arguments, and it just makes me even more convinced of the problem.

But believe it or not, I don’t even have to worry about why they are having the problem. The fact that their revenue is simply not growing fast enough is evidence enough, and when I present this to my clients and I mention some of the things that you say, their comeback is well, maybe they will figure it out.

And it’s true, they may be able to figure it out. But how is that different than in March 2000 at the top of the Internet bubble, when people were saying maybe this company that is coming to market with no assets, no properties, nothing is going to make money? This is true, but I would much rather—with my money at least—invest in a company that has a proven business model and has a consistent and regular earnings stream than one that you are basically hoping on a prayer that maybe it will work out.

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Tickers Mentioned: FB, GOOG

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