Facebook (FB) has had quite a run in 2015. Shares of Facebook stock are up about 31% year-to-date as of this writing while the S&P 500 index has declined about 2%.
Continued strength in user growth and earnings has propelled FB stock higher in 2015, but investors always need to know what they can expect from a company going forward.
Can Facebook continue growing as we enter 2016? Here are three pros and three cons to help you find the biggest opportunities and risks of investing in FB stock.
Facebook Stock Pros
Big Spending on R&D: You might think it’s weird to place one of FB’s biggest expenses at the top of the pros list, but hear me out. Facebook’s R&D budget has doubled through the first nine months of 2015. Year to date, FB has funneled 29% of revenue back into research and development. Facebook operates in a competitive market, where switching costs, while not quite zero, are not terribly expensive. We’ve already seen the start of fewer teens using Facebook. With competitors like Twitter (TWTR), Snapchat, Pinterest, Kik, Viber, and dozens of other social messaging apps continuing to grow their user bases, FB must stay one step ahead in product development. Facebook stock investors also benefit from R&D money going towards Facebook’s deep learning AI algorithms, which help FB produce more engaging news feeds, better targeted ads and ultimately more revenue.
Instagram Ads: Instagram is probably top of the mind when investors think of the big growth opportunities for Facebook stock. The FB subsidiary added over 100 million active users in 2015, growing over 33% from the end of 2014. Most importantly, the company just opened up its advertising API to everyone, turning on revenue growth for Facebook stock investors. eMarketer expects Instagram to generate $1.5 billion in ad revenue next year and nearly double again in 2017 producing $2.8 billion. As Instagram continues to grow its user base at a faster rate than the more mature Facebook and expand the number of businesses advertising on the platform, it’s sure to provide a significant boost to Facebook stock revenue. By 2017, Instagram will likely account for more than 10% of FB’s total ad revenue.
Oculus: The virtual reality startup Facebook purchased in early 2014 for $2 billion is about to start making some real steps toward providing an ROI for Facebook stock investors. After a deal with Samsung (SSNLF) to bring its technology to the Gear VR, Oculus will have its first branded hardware unit ready for mass distribution in 2016. Mark Zuckerberg touts VR as the next big computing platform after mobile, and early demos have shown huge promise. Forbes’ Dave Thier had this to say about the upcoming headset: “The ability for two people on opposite sides of the planet to feel like they are physically in the same room could represent one of the biggest changes in communications technology in years, maybe decades.” While it’s unlikely to become mainstream for several years, VR has a lot of potential for FB stock.
Facebook Stock Cons
It’s Expensive: Shares of Facebook stock are currently trading hands at 18 times sales and over 100 times earnings. Comparatively, Twitter trades for less than nine times sales, and LinkedIn (LNKD) trades for 11x revenue. Such a high valuation means that one false step from management could cause the stock to plummet. We saw that happen to Twitter earlier this year. In March and April, Twitter stock traded around the same valuation FB stock currently holds. After a bad earnings report, it fell to a P/S ratio of around 15, and after another it fell down toward the single digits.
Declining Engagement on its Flagship Product: While FB’s user base continues to move impossibly higher (1.55 billion as of September), the percentage of users actively contributing content to the network has declined. The Wall Street Journal reported last month that just 34% of Facebook users updated their status during the third quarter, and 37% shared their own photos, down from 50% and 59%, respectively, last year. Facebook thrives on having varied content to show users, especially from regular friends. That gives it content to advertise against and gives incentives to businesses to promote their posts to help them stand out in the news feed. To be sure, Facebook still has 500 million users actively posting content, but the trend isn’t promising.
Heavy Reliance on Exchange Rates: Facebook’s strongest market is currently the United States, but the majority of its user growth is coming from developing markets. Meanwhile, its monetization of Europe and Asia remain significantly lower. Despite faster user growth abroad, Facebook’s sales in the U.S. and Canada have grown faster than any other market. Going forward, Facebook stock investors will come to rely on foreign currency exchange rates with the dollar for Facebook to maximize revenue. While that’s something management can control to a certain degree with hedges, it’s not the best position to be in.
Bottom Line on Facebook Stock
While Facebook trades at a sky-high valuation and there are some questions surrounding its flagship product, the company still looks deserving of its price. The potential of Instagram and Oculus, not to mention Messenger, WhatsApp, and all the new features and artificial intelligence it’s working on with those R&D dollars will keep it growing strong.
No other company has ever had as many “customers” as Facebook. That fact alone should help ease the concerns around the big blue app’s engagement rates and any questions about teenagers abandoning it for other apps. Meanwhile, it’s well on its way to three other properties with 1 billion users, so it has diversity to weather any storms.
So, should you buy Facebook stock?
Yes — it’s in a strong position to keep growing despite a couple headwinds in the foreseeable future.
As of this writing, Adam Levy did not hold a position in any of the aforementioned securities.
