In Tactical Luddite numbers 1, 2, and 8, we touched on one of the core requirements of Value Investing: the ability to judge a stock based on its value proposition alone; regardless of your personal feelings about the company.
And so it is with Facebook, or Meta as it likes to be known. Facebook has a price at which it is attractive to own, regardless of my (or your) feelings about the company. The big question is, What’s that price?
The process of determining that price is called Fundamental Analysis, and in this issue of Tactical Luddite, I’ll walk through the key metrics as I use them, both personally and in Barrier Island Capital Partners, LP, the investment partnership I co-manage.
Price To Earnings Ratio
The P/E ratio is probably the most well-known Value Investing metric in history. Theoretically, the P/E ratio tells you the price you’re paying for one share of a company’s earnings. However, since Facebook has never paid a dividend and most companies don’t come close to distributing all of their profits to shareholders as dividends, this is purely theoretical. Still, the fact remains that a lower P/E indicates an attractive share price for a given amount of earnings.
Despite being a “tech” company, FB performs quite well here now that they’re down 40% from their all-time highs. The 4 year average P/E at the current price is 22. If you look only at 2021, their P/E is 13.58, which is very attractive. However, I don’t just want something that’s attractive or cheap; I want a “steal.” I want a price where the 4 year average P/E is at 13 or below.
Price / Net Current Asset Value Per Share
Another traditional Value Investing favorite, the NCAV is simply the value of the current assets (generally considered “short term” and easily and quickly sold) minus the TOTAL liabilities of the company, including long-term liabilities. It’s somewhat unfair, subtracting a company’s entire liabilities from their short-term assets. However, if this number is positive, it represents great financial strength. It means that a company could pay off all of its liabilities using only liquid assets.
When you compare the share price to the Net Current Asset Value, you get not only a measure of the solvency of the company (they can pay off their liabilities), but also the value: a low Price/NCAV tells us that a company is comparatively “cheap.” I like to see a P/NCAV of 13, although this isn’t the way that Benjamin Graham looked at NCAV. Be that as it may, many large popular stocks don’t even have a positive NCAV, like Amazon (AMZN), Tesla (TSLA), or Costco (COST), let alone a P/NCAV of anything below 30, so I stick with 13 as a good, safe measure of value.
Facebook’s 4 year average P/NCAV at current prices is 18. This is fairly close to my target, and gives me a clue that Facebook’s price doesn’t exactly have to collapse from here in order for me to get interested in buying.
Price / Book Value
Another traditional valuation measure, Book Value tells us how many more total assets than liabilities a company has. One of those old-fashioned ideas at play - companies that have more assets than liabilities have far more margin of safety and ability to stay in business than highly-leveraged businesses with tons of liabilities (usually in the form of Long Term Debt). Traditional wisdom from Benjamin Graham called for a Price/Book Value of 1.5 or less. If it’s good enough for Ben Graham, it’s good enough for me; my target is also Price/Book of 1.5 or less. However, I am willing to see a higher ratio if there’s a compelling reason, like high Free Cash Flow.
Price To Free Cash Flow / Share
Free cash flow is the the amount of cash coming into the company’s coffers minus the cash that they spend for all expenses. It adds back in several non-cash items that are subtracted from income for tax reporting (like depreciation). Positive free cash flow is a huge deal because it means that a company doesn’t have to borrow or issue shares to fund its operations. (One of the big bugaboos about Netflix, for instance, is that they’ve constantly had to borrow money to fund their content creation (2020 not withstanding).
The great news here is that FB is a cash cow; they generate tons of cash from their operations. (Great news for them, and possibly bad news for their customers, but remember Rule Number One of Value Investing). Average Free Cash Flow per share for the last four years is $9. Not only that, but it’s increased each of those years. The Price/FCF per Share averaged over the last four years is 25. My preference is no more than 15.
P/E / (NCAV+FCF)
My last major metric is perhaps unconventional: the P/E ratio divided by the sum of the NCAV per share and the FCF per share. If this ratio is equal to 1.0 it means (to me, not necessarily mathematically), that the P/E of a company is under-pinned by an attractive balance sheet (the NCAV) and that the business is operating efficiently (the FCF). It’s kind of a shortcut to compare two or more companies that have good value according to some metrics, but not in others. My cutoff is 1.5; ratios at or below this level indicate value. Facebook’s four year average comes in at 1.0 based on current share price, which means that this metric looks extremely attractive already.
Putting It All Together
Once I’ve determined the ratios at current prices, I start figuring the price at which all of my criteria are satisfied. In the case of Facebook, the price needed to meet all of these criteria comes out to $46 per share. That would be a 76% drop from here. I’m inclined to throw that out, though, because it’s primarily the Price / Book Value that’s causing this. At a price of $46, the average P/E would be 4.76 and the Price / (NCAV+FCF) per share would be 0.23. Both of these metrics are absurdly low.
Given the very tidy balance sheet and high Free Cash Flow, I believe I would acquire shares at $130 per share. Here are my valuation metrics at that price:
P/E (4 year average): 13.46
P/(NCAV+FCF)/Share (4 year average): 0.66
P/Book Value (4 year average): 4.20
The fly in the ointment is the Price to Book Value number. This is tremendously higher than I would normally be comfortable seeing for most “deep value” plays. However, buying Facebook shares at $130 would represent a more than 66% decline from its all-time high of $384. For a company with great cash flow and such a strong balance sheet, a 66% drop is enough to satisfy me. If the market continues to drop and shares of Facebook get to the $130 level, I’ll be buying.
What Is Left Unsaid
Notice that what I didn’t mention is the actual business. I didn’t talk about Facebook’s deep dive into the Metaverse. I have no opinion about their business model, but I do know from my insurance business that advertisers continue to cough up money to advertise on their platform. As a Luddite, what little of the Metaverse I know about seems foolish and stupid to me. But, all of that is irrelevant in determining the price at which I believe shares are a screaming deal.
Update On RGR
As of Wednesday the 25th, RGR is trading at $66.07 per share, a decline of $2.81, or almost 4.25% from my purchase price. Given that the S&P 500 has traded down 4.8% and the NASDAQ down 11% or more, this provides short-term confirmation that RGR is functioning as a value pick should: it’s not getting cratered in the short term. If RGR stays below my original purchase price, I may well buy more. It should go without saying that, as a value investor, I’m not concerned with RGR’s performance over such a short time horizon (slightly more than one month); I mention it here simply because of the volatility the overall market has experienced recently.
Tell Me What You Think! (Please And Thank you!)
What do you think of FB as an investment? Do you own it? Will you buy more shares? Please comment below or send me an email at joe@jlarroyo.com