Social media firm Facebook Inc (FB) offered shares to the public for the first time on May 18, 2012, at $38 per share. Since then, Facebook stock has only really had one prolonged moment of worry — the first few months of trading, as shares dipped all the way down to $18. Otherwise, it has been mostly smooth sailing for FB, with the stock throwing off 500% returns.
And with that has come some pretty frothy numbers.
Based on just about every traditional value metric, Facebook stock looks expensive. FB sports a price-to-earnings ratio of 85, a forward P/E of 26 and a price-to-sales ratio in the high teens.
Heck, even the nominal share price — which has been in triple digits for most of the past four months — is a little steep for your mom ‘n’ pop investors.
But as long as you have something to justify those numbers, you don’t have anything to fear. And Facebook stock has that something — potential growth — in spades.
The Growth So Far? Impressive.
Facebook has been a rapid grower since coming public. Revenues of $18 billion in 2015 were nearly 400% higher than the full year before Facebook’s IPO. The vast majority of revenue stems from advertising, and that has shot up like a rocket, too, from $943 million in Q4 2011 to $5.6 billion in Q4 2015.
But what matters going forward — and what Facebook stock will need to achieve its lofty valuations — is future growth.
Luckily, by that measure, FB looks great.
Analysts are expecting sales growth of more than 40% to $25.5 billion this year, slowing to “just” 33% to $33.83 billion next year. That’s expected to drive earnings growth of 37.7% to $3.14 per share this year, followed by 31.5% growth to $4.13 per share in 2017.
Let’s investigate how Facebook might get there.
Global daily active user (DAU) growth has slowed to 3% as of the most recent quarter, but that’s still an impressive number given that FB currently sports more than 1 billion DAUs in a fairly even mix among North America, Asia, Europe and the rest of the world. Monthly active users are now at 1.6 billion.
Facebook’s mobile DAUs have more than answered the big concern when FB went public as to how the company would navigate the shift from computers to mobile smart phones and related devices. Mobile DAUs are sitting at 934 million and will probably hit more than 1 billion this year.
And Facebook is monetizing that traffic, too, controlling an estimated third of the $15 billion mobile display ad market in 2014, ahead of Alphabet Inc’s (GOOG, GOOGL) roughly 12% and Twitter Inc’s (TWTR) 7%.
FB: Pay Up for Growth
Yes, new money would be paying some 50 times trailing free cash flow and 27 times forward earnings for Facebook stock.
However, once you factor in growth, Facebook more than justifies these prices. Consider this:
Facebook trades at 27 times forward earnings, which is significantly more than the S&P 500’s 16.7 multiple. However, Facebook is expected to grow earnings roughly 32% per year, while the S&P 500 is projected to grow earnings just 6% annually over that time.
So, if we calculate their price/earnings-to-growth ratios, you actually come to 1.1 for FB, and 2.83 for the S&P 500. With PEG, 1 is considered fairly valued, with anything lower considered undervalued, and anything higher deemed overvalued. When you consider growth, then, Facebook is pretty fairly valued compared to a broader market where investors are paying way, way too much for modest expansion.
Even if you still want to say that Facebook is overvalued, it’s been proven time and time again that you can pay a high valuation and still come out wildly ahead.
Back in 2005, analyst Dreyfus Neenan at Morningstar performed a study of the top 50 growth stocks in 1990, 1995 and 2000 to examine how high a price-to-earnings ratio one could have paid and still come out ahead.
At its extreme, investors could have paid a P/E of as high as 577 for semiconductor stock Qualcomm, Inc. (QCOM) back in 1995 and still outperformed the market over the next 10.5 years (by quite a lot, actually). Qualcomm’s actual P/E at the time was “only” 78 — which obviously might have seemed high at the time, but ended up being a steal.
That’s especially true when you consider QCOM stock has put out a total return of some 1,900% since its high point in 1995, versus “only” 425% for the S&P 500.
The point of the study? A high P/E doesn’t necessarily mean you can’t get boffo returns from a stock. So why sweat it, even if Facebook is trading at more than 80 times trailing earnings?
Growth Through Acquisition
Another growth avenue for Facebook is to acquire rivals that threaten its core business, as it did with Instagram, WhatsApp and Oculus, the last of which develops virtual reality applications and devices. Facebook also can create new ways for people to communicate, such as with its Messenger service. All of these hook users in and can complement its namesake application.
The Oculus purchase has great potential. Oculus has developed a virtual reality headset called Rift that could end up revolutionizing they way people play video games, watch television shows and movies, and even interact with friends. CEO Mark Zuckerberg fully believes the technology could become an important part of daily life for billions of people, including for entertainment purposes but also to connect with friends, and even do work, such as training courses and interacting with colleagues around the world.
The Rift accepted pre-orders on Jan. 6 at $599 each, and after less than two weeks, the gear was backordered for four months. This is a promising start.
Bottom Line on Facebook Stock
Facebook is dominating digital advertising, and it has a number of growth drivers — between additional social platforms and the potential for VR to explode — that can push FB shares higher.
Going off a discounted cash flow (DCF) valuation, Facebook stock should be trading closer to $150 per share, and that’s even leaving some cushion should growth levels not come in quite as high as expected.
That’s more than 30% higher from here.
As of this writing, Ryan Fuhrmann was long FB and TWTR.
