Now that Facebook’s S-1 is out in the wild, reports are beginning to crop up that question what Facebook’s valuation should be, given its revenue, profit, and the growth rates of both figures. Certain well read analyses peg the firm’s potential revenue and profit growth in the mediocre range, which I think is actually quite wrong. Here’s my take:

Let’s talk technical for a minute. A P/E ratio is the comparison of a company’s share price to its earnings per share. Therefore, if a company was trading at \$10 a share, and had profits of \$1 a share, it would have a P/E ratio of ten. In normal terms, the higher the P/E ratio that a company can command (it is set by the market’s will), the faster that the company is likely (as thought by the market) to grow.

This brings in our next term: P/E/G, or the Price/Earnings/Growth metric. To ascertain a stock’s P/E/G ratio, simply divide the firm’s P/E ratio by its growth rate. If your stock that had a P/E of ten was growing at a ten percent growth rate, then it would have a P/E/G of 1. Generally speaking, this metric is used to help put a company’s P/E ratio into context.

If the firm has a P/E/G of over one, meaning that its P/E ratio is larger than its growth rate, that is generally considered a sign that the firm is overvalued, or is trading at too high a price for its fundamentals. A company that has a P/E/G of less than one, so that its growth rate is higher than its P/E ratio, is generally considered to be a potential value stock.

This is why revenue growth matters greatly in the pricing of stocks. We’ll use Facebook’s net profit of 1 billion dollars in 2011 as an example. Facebook’s net profit rose 65.2% from 2010, to 2011, from \$606 million, to \$1 billion. Therefore, being overly simple, using a P/E/G of 1, Facebook would be valued at some 65.2 billion (To make that simpler, to get a P/E/G of one, the P/E ratio must be equal to the firm’s annual growth, so in this example, Facebook would have a P/E of 65.2. For comparison LinkedIn has a P/E of 1,507).

Now, all that aside, why does it matter? Because if Facebook’s profit growth rate declines sharply, it could negatively impact Facebooks’ market value, even in the face of expanding revenues. Therefore, the ability to grow its profits is essentially the one key metric that Facebook has to deliver on in order to maintain the growth of its aggregate market value.

Does Facebook have that ability? Much has been made over these charts, from the firm’s S-1:

If you look at the two graphs, which are very important for Facebook, you will note a rather dull, linear rate of growth that tapers off towards the most recent entry. Is this cause for alarm, as at first blush, it seems that Facebook is slowing down? I don’t think so.

Primarily, there are only so many people online, total, so to see Facebook slowly have a harder time signing up the next hundred million users, and getting them integrated into its ecosystem, is not surprising; it was bound to happen.