Goldman Sachs invests in Facebook at $50 Billion valuation

Yup, let's judge people by their former employers, not by their actions. I mean, Hank Paulson's decision not to bail out Lehman would have been totally OK, have he not been former Goldman CEO...

Yeah, I was thinking of the 30-60 year timescale. The higher P/Es you're talking about are either the result of suckers or the result of expectations of continued substantial growth over the next decade or three. The historical average is brought up by companies like Apple and Oracle.

Long-run stable P/Es could rise if the internal rate of return of the economy as a whole fell, so that a good safe investment was one that paid 2% instead of 4% after inflation. That could happen under circumstances like these:

- If the peak-oil doomers turned out to be right, and our economic growth actually does turn out to be contingent on continually increasing fossil-fuel consumption; or

- If much of what we think of today as "profit" was actually destructive extraction of natural resources (e.g. overfishing); or

- If some kind of sustained disaster makes profitability difficult (e.g. the aftermath of global thermonuclear war, widespread coastal flooding destroying coastal cities, widespread Farmville addiction, or the gradual collapse of the Westphalian state system in the face of decentralized guerrilla warfare); or

- If we shift to a less efficient way of allocating productive resources than transparent capital markets, to an even greater extent than currently (e.g. war and other forms of theft, taxation for the benefit of wealthy bankers, insider trading, central government planning for the benefit of the politically well-connected).

I consider these scenarios unlikely.

If, by contrast, we keep inventing and putting into practice ways to produce more and more value for less and less effort and natural resources, and knowhow becomes more easily accessible rather than less, then we can expect that the internal rate of return that stocks must compete with in order to get investment dollars will go up. Which means long-run P/E ratios will go down.

To make this concrete, suppose that in 2029, you have US$20 000 to invest. (I'm speaking in 2011 dollars here to avoid talking about inflation.)

In 2029, Apple has settled down to a share price of $100 with annual earnings of about $10 per share (a P/E of 10:1), and no particular expectation that that is more likely to go either up or down in the next few years. So you could buy 200 shares of Apple and get about $2000 a year out of it, with some risk that Intellectual Ventures Hummer Winblad will get greedy and sue Apple into bankruptcy two years from now.

Alternatively, you can buy solar panels and sell the power back to the grid at the going wholesale rate of $0.015/kWh. In 2029, silicon solar panels have finally been edged out of the market by quantum-dot solar panels, which have an energy payback time of 3 months in a sunny climate. Like silicon solar panels, they're made out of some of the most abundant materials on the planet, and their fabrication is fully automatic, so essentially all of their cost is profit, the cost of the risk capital invested in their manufacture, and the energy dissipated in their manufacture. The energy dissipated is $0.033 per average watt, $0.011 per peak watt, but because of the large investments involved and the rapid expansion of solar panel manufacturing, that's only 10% of the actual purchase price of $0.11 per peak watt.

So instead of buying the Apple stock, you can buy 180 peak kilowatts of solar panels, which will generate 60 kilowatts, averaged over day and night, winter and summer. Instead of earning you $2000 per year, this will earn you $7900 per year, and your only risks are that energy prices fall further or someone steals your solar panels.

Since your objective in this investment is to make money, you buy the solar panels, as does everybody else. People sell their Apple shares in order to carpet the Gobi with solar panels. Consequently Apple's share price falls. Eventually it reaches US$25 per share, at which point its P/E is 2.5:1, and it's competitive with the solar panels again.

As long as there are investments available with rates of return similar to those I've postulated for solar panels above, shares will tend toward that 2.5:1 P/E ratio. They aren't doing it now because there are only very limited investments available with such high rates of return: installing a more efficient furnace in your house, maybe, but how many houses do you have? Solar panels, though, and thorium extraction from seawater, and automating custom manufacturing --- those are scalable investments.

Stocks make investors (contrasted with traders) money either by (a) going up in price or (b) paying a dividend every quarter. In order to make your stock price go up, you have to show not just profits, but growing profits. With something like Wal-Mart, this just means either cutting costs or selling more stuff to more customers. However, Facebook is going to (over the next few years) approach market saturation - they hit 500 million users 6 months ago, and there are only two billion internet users world-wide, meaning they can't keep growing at their historical pace forever. As that user growth slows, there are two ways to increase revenues (and profits) - either extract more money from each user or diversify into other products or services. If they can't do that, then they have to reorient into a "own our stock because we pay dividends" slow-growth company like Microsoft.

Most tech companies do stock buybacks rather than dividends. From the point of view of shareholders, it is almost the same thing.

Here are the differences. Dividends generate ordinary income, which people may have to pay taxes on. Dividends drop the price of the stock by the amount of the dividend.

By contrast a stock buyback reduces the value of the company and the outstanding stock by the same amount, and therefore leaves the stock price alone to first order effects. Over time this increases the likelihood of incurring long-term capital gains, which are generally better from a taxation purpose.

The never stated difference, which I think is important, is that dividends hurt anyone holding options, while a stock buyback increases volatility which helps anyone holding options. Since tech companies tend to have lots of employees with options, this matters a lot to them.

Very few, and why does anybody buy their stock? This guy I know has been borrowing more and more money for years and never paid a red cent back, and now you want to lend him your money?

A share of a company is in theory optimally priced when it has the same value as the net present value of all future income streams that come from it: that includes both its dividends, and any profits from reselling it. Assuming we're talking about a company that is no longer growing (that's the presumption in the post you are replying to), then owning a share of it has negative value unless its dividends (or moral equivalents, like share buybacks) exceed at least the rate of interest - you can earn more risk-free by putting your money elsewhere.

> I'd say that if a company has extra cash, it is better off paying its long term debts rather than dishing it out to the shareholders.

That kind of blanket statement makes absolutely zero sense to me, and surely if you thought about it for more than 5 seconds, you too can see how silly it is. If the company's return on borrowed money is higher than the interest rate it pays on that borrowed money, paying down the loan would be a waste of money.

Consider a large shop that has a mortgage on its premises. Is it best for it to invest all its profits in paying down its mortgage? Or should it open up a new branch elsewhere instead, borrowing the money for the premises, on the basis that its business model has been proven to have profit that exceeds the cost of finance? Which would make more money? Now consider another scenario: rather than the shop opening up a new branch, what if the investors (i.e. the owners) want to invest in a different or new business, with potential for higher returns in the future?

That speaks more to the quality of your Facebook campaigns than Facebook's profitability.

The guys actually spending significant money on Facebook are not paying more than 30-40 cents CPC.

Can you unpack this a bit more? I'm still not sure who you're claiming has power in this situation, and why that makes GS want to buy FB stock.

Or Goldman is so loaded with money that they have to put it somewhere - anywhere.