What Is Facebook's (NASDAQ:FB) P/E Ratio After Its Share Price Tanked?

All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" See our latest analysis for Facebook ” data-reactid=”21″>See our latest analysis for Facebook

How Does Facebook’s P/E Ratio Compare To Its Peers?

Facebook’s P/E of 22.54 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (19.7) for companies in the interactive media and services industry is lower than Facebook’s P/E.

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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Its relatively high P/E ratio indicates that Facebook shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.” data-reactid=”36″>Its relatively high P/E ratio indicates that Facebook shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Facebook’s earnings per share fell by 15% in the last twelve months. But EPS is up 42% over the last 5 years.

Remember: P/E Ratios Don’t Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Facebook’s Balance Sheet

With net cash of US$55b, Facebook has a very strong balance sheet, which may be important for its business. Having said that, at 13% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Facebook’s P/E Ratio

Facebook has a P/E of 22.5. That’s higher than the average in its market, which is 12.7. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. Given Facebook’s P/E ratio has declined from 33.1 to 22.5 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.