Facebook plans to sell its shares to the public this spring.
This Initial Public Offering (IPO) will be the largest ever and signals the most exciting offering since Google went public in 2004.
Facebook is the largest social media company by a large margin and the company's IPO deserves the interest it has been attracting.
Whether or not the stock will be a good purchase is a much more difficult question to answer.
Our fundamental analysis of stocks focuses on two questions.
The first is whether or not a potential stock represents an ownership interest in a high quality business.
Part of this analysis addresses the sustainability of the business through different market cycles and changes that could take place in the unique market for the goods and services of the company.
The second question is whether the market price is lower than the value we believe the business is worth.
Within this framework, Facebook meets the first test easily.
Facebook is a unique platform.
According to the company's SEC filing, 845 Million registered users used the service within the last month.
Of those, more than half (483 million) log into their accounts daily.
For perspective, these numbers dwarf the total population of the United States which was 309 million as of the last census in 2010.
These users spend an average of between 7 and 8 hours per month on Facebook, consuming almost 15% of the total time spent on the Internet.
The total amount of time that users spend on Facebook is much higher than any other Internet property by a wide margin.
Users must submit their name, date of birth, gender and email address to open an account with Facebook.
However, most users submit much more granular data including their job, education, marital status, hobbies, interests and favorite songs, movies and TV shows.
Finally, users "like" content, join groups and establish connections with friends providing Facebook with an incredibly rich portrait of each of their roughly 850 million subscribers.
Advertisers are able to target campaigns to those users who they believe would be most interested in their goods or services.
Facebook presents a case study on its advertising page for a photography company that primarily photographs weddings.
The company's ideal customers are 24-30 year-old women who recently became engaged.
Facebook's data allowed the company to target these prospective customers with pinpoint accuracy so that a $600 ad led to $40,000 in business over 12 months.
Advertising represents about 85% of Facebook's revenues.
The company's advertising platform has allowed the firm to grow revenues at incredible rates of 88% during 2011 and 154% the previous year.
Facebook's business is also extremely profitable.
During the past two years, the company's earnings have expanded from $229 million to $1 billion.
The business is highly leverageable.
To generate this income, Facebook only employs about 3,200 people.
Facebook provides a digital frame while its users add incredible amounts of content without any intervention from Facebook's employees.
This content in turn makes the site more attractive to existing users, prospective users and advertisers.
Facebook also benefits from the "network effect.
" The network effect occurs when the additional users of a service increase the value of the service for others.
Facebook grows because more and more people are on the platform making it more useful to others to join.
Likewise with advertisers, as more users join Facebook and spend additional time on the platform, Facebook becomes a more attractive media.
Companies such as Facebook that benefit from this network effect tend to become natural monopolies.
Facebook struggled after its creation to distinguish itself from Friendster and MySpace.
However, once Facebook became the dominant social media site, challengers such as Google+ find it very hard to attract users and compete since everyone is already on Facebook.
Facebook is already a dominant advertising platform and is growing quickly in electronic payments.
Many users play games such as Zygna's CityVille and purchase virtual goods over Facebook's network.
Facebook garners revenue from these transactions.
However, given Facebook's huge network of users, the company could expand its business lines dramatically.
For example, Facebook could distribute music, software and movies.
Its potential future businesses are truly limitless.
Similarly, Amazon morphed from an online bookstore into one of the world's largest retailers, a cloud storage company and a media delivery service.
Very few analysts were able to foresee these developments in the late 1990s when Amazon was primarily competing with Barnes & Noble and Borders (now bankrupt).
Facebook, however, faces a continuing challenge that could threaten its viability as a company.
This challenge is the natural tension that exists between Facebook's utility to its users and its need to monetize its business and profit from its platform.
Facebook's users could become apprehensive if the company tried to advertise too aggressively based on interactions that its users view as personal.
For example, imagine complaining to a friend on Facebook about your "love handles" and then seeing a blinking banner ad for a doctor who performs tummy tucks.
Overly intrusive advertising caused MySpace to lose its first mover advantage to Facebook such that MySpace is now a niche media platform that will never be able to challenge again for dominance in the broader social media arena.
As discussed, Facebook stores an incredible amount of very private information on its servers.
Since no security system is impenetrable, it is not hard to imagine a motivated hacker causing an epic privacy breach.
Aside from bad actors, governments could also impose privacy protections that make the site much less attractive to its user base and/or advertisers.
It is impossible to determine whether or not Facebook will be a prudent investment since the price for the IPO has not been set.
However, trading on SecondMarket (a market for pre-ipo companies) suggests the bankers will value the company at a market capitalization of about $100 billion.
Facebook's closest comparable is Google since both companies are dominant advertising platforms.
Google's market capitalization is now about $208 billion or roughly twice Facebook's expected value.
In 2011, Google's sales were $37 billion and the company earned $10 billion on those revenues.
Facebook's sales during the same period were about $3.
7 billion and the company earned $1 billion on the revenue.
Interestingly, Google's sales and earnings are about 10 times as large as Facebook's, but its market capitalization is only twice that of Facebook.
Facebook's revenues and earnings are growing at a much faster rate than Google.
For instance, Facebook grew its revenues and earnings 88% and 65% respectively.
On the other hand, Google grew revenues 29% and earnings 14% during 2011.
Assuming Google, grows at 10% rate forever, then Facebook would have to grow at 25% for next 18 years to be an equivalently sized company.
This rate of growth would very difficult to sustain for almost two decades.
Facebook is an intriguing company and does not deserve to be dismissed as an over-hyped flash in the pan.
Its platform of users will allow the company to become dominant in the advertising arena very quickly.
However, any missteps in monetizing its user base could cause the network effects to reverse themselves, as has occurred with other social media companies.
NewsCorp acquired MySpace in 2005 for $580 million and then sold the company to Specific Media and pop star Justin Timberlake for only $30 million in 2011, after alienating its user base by intrusive advertising.
In the final analysis, the reward may be limited if the IPO is priced high and the risks are substantial.