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That Idiotic $1 Billion Purchase of Instagram by Facebook? Maybe Not So Dumb

Remember how dumb it sounded a year ago when Facebook (FB) paid $1 billion for the photo sharing sight Instagram, a baby of a company with no profits and little track record? It doesn’t look so stupid any more. In fact, Facebook investors may find more solace considering Instagram’s future than that of Facebook itself.

A Piper Jaffray study released Wednesday showed that Instagram is gaining on Facebook as teens’ favored social network. Facebook still has more fans than any other site, but only 33% of the teens recently surveyed ranked it as their favorite, compared to 42% last fall. Twitter has risen in popularity to become a close second. Instagram, in third place, took a 17% share, up from 12% at the last survey. In other words, most of Facebook’s loss came from the rise of Twitter and Instagram.

It revives a basic question for Facebook investors: will future generations spend as much time on Facebook as today’s teens and adults? Or will the ever-growing competition for their attention prevent Facebook from living up to the huge growth this PE ratio implies?

FB Forward PE Ratio Chart

FB Forward PE Ratio data by YCharts

The study reminds us of the constantly changing tastes of teenagers, and the variety of entertainment sources they have in front of them. Teenagers are a huge part of the audience Facebook taps to attract paying advertisers. Although they have consistently flocked to Facebook and Twitter most in recent years, the study points out that non-network sites like Google’s (GOOG) YouTube suck away a lot of their time. So does Wanelo, Vine, Snapchat and several other sites that remain invisible to most people over 40. Smartphone and tablet apps for these sorts of sites often pop up unexpectedly on Apple’s (AAPL) most downloaded lists.

Last week, Facebook unveiled the “Facebook Home” smartphone page that’s supposed to help keep everyone’s eyes focused on Facebook instead of Google or other competitors. The home screen puts your Facebook updates front and center on smartphones, obscuring the competing apps most people usually see there. Silicon Valley types were underwhelmed, predicting that it might at best make already heavy users of Facebook even more Facebook focused. But industry analysts that follow Facebook were generally much happier with the development, as seen in a stock chart.

FB Chart

FB data by YCharts

For shareholders, it’s nice to know that Facebook owns some of the toughest competition. For now, anyway.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.

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