[ikono]

> "What, exactly, other than a sneaking suspicion that Facebook might not be worth it's valuation? Clearly some people, the people buying Facebook stock, disagree with you. Why are you right and they're wrong?"

It's not about anyone being right or wrong. The future is inherently uncertain. Investing is about making a bet that will pay off on average. As valuations go higher and higher, it becomes more and more likely that people are only going to make money on an above average future. That's a bubble, and the longer it takes for a below average future to come the bigger that bubble will grow.

[gfodor]

You're not totally wrong, but this is a 'first-level' analysis that is devoid of any real depth or understanding. I generally expect more of The Economist. The point is to try to explain the world in a way that makes sense despite the uncertainy, giving specific examples that explain the reason for high valuations and why those valuations are unjustified.

[ikono]

You're taking the stance of investors are valuing Facebook and the like at X. Prove that's wrong. I think in general if you're going to value companies at significantly abnormal multiples of earnings. The burden of proof should fall on the person assigning those multiples.

But I'll play along anyway. I'll use Facebook as an example. One of the reasons for Facebook's lofty valuation is the very thin trading volumes. People are buying/selling very small $ amounts of Facebook stock in a private market at very high valuations. Imagine company X has one million shares of stock outstanding and I sell 1 of them for $100. Do you think company X is worth $100 million? If so I've got an endless supply of companies for you and I'll even be silly enough to part with them for the bargain price of $50 million. One of us will be rich...

So I contend that the published valuations are somewhat meaningless. The question then becomes what is a company like Facebook worth? Generally there are three main factors that determine a companies value. Tangible assets (cash in this case), earnings, and the value of retained capital. The first is easy and relatively insignificant in this case. The second is very hard, the third is just about impossible. My point is simply that high valuations relative to earnings should imply that there is a very high probability of significant growth in earnings. I think the people that believe in Facebook believe in what it could become not what it is today. If that's true, then the true profit engine is vaporware and it is therefore impossible to have enough certainty in a sufficiently positive future to justify the earnings multiple.

Now one example doesn't prove the point but I do think there is enough anecdotal evidence to justify thinking about the possibility of a bubble.