Facebook Inc (NASDAQ:FB) stock tumbled last week despite absolutely crushing Wall Street’s quarterly estimates, but FB stock appears to have stabilized over the past few sessions.
It was a stunning selloff and had nothing to do with past results. Rather, as stocks are wont to do, the price reflected future prospects. In that regard, FB stock spooked the market badly.
Growth is going to slow down next year, higher costs and the law of large numbers are partly responsible for the drag, but the biggest issue is ad load. That’s the number of ads Facebook can stuff into the news feed, and it’s getting saturated. As CFO David Wehner told analysts on a conference call after the quarterly report:
“[A]s I mentioned last quarter, we continue to expect that ad load will play a less significant factor driving revenue growth after mid-2017. Over the past few years, we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully.”
“Meaningfully” is code for a lot. It’s not that Facebook won’t be growing the top line by leaps and bounds anymore. It’s just that the rate of growth can’t be maintained. It’s reflected in analysts’ sales estimates for 2017. For the current fiscal year, Wall Street expects revenue to increase more than 50%. Next year, however, is a different story. Analysts are looking for growth of 35%.
Part of what gives an equity the designation of “momentum stock” is accelerating top-line gains. As FB’s revenue growth rate cools off, investors are going to pay a lower and lower premium for earnings. That’s actually kind of good news for investors in FB stock.
FB Stock Is Strong on Valuation and Technicals
The market usually overdoes it on the downside. That allows stocks to become mispriced in an investor’s favor. Any time a name is beaten down more than it ought to be, you’ve got a bargain on your hands.
It looks like this scenario is playing out with FB stock. Shares bounced off a post-earnings low, but they’re still only up 3% in the past six months to the 10% gain put up by the Nasdaq. That brought the forward price-to-earnings multiple down to compelling levels.
Investors are willing to pay less than 24 times forward earnings for Facebook stock. That might look at expensive at first. After all, it’s much pricier than the broader market. But then, the S&P 500 has nowhere near Facebook’s growth potential.
Analysts on average expect FB to deliver a compound annual growth rate of 35% over the next half-decade. Ordinarily, you would expect that sort of outsized growth rate would warrant higher price-earnings ratios. If FB’s top-line expansion is slowing down, then by all means the name needs to suffer a little multiple contraction. But current P/Es are too much.
Click to Enlarge FB stock is now trading at a 40% discount to its own five-year average, according to data from Thomson Reuters Stock reports.
Mind you, even at this new “poky” pace, FB’s revenue is forecast to increase revenue by 35% next year. True, multiples and revenue projections don’t run in tandem, but a 40% drop is too much for a company that’s expected to build its top line like that.
Besides, between its SnapChat killer and virtual reality, the social network could have more tricks up its sleeve.
FB stock crossed through its 50-day moving average last week. It was even briefly oversold. Then shares found support at their 200-day moving average. The robots were probably the cavalry in the drawdown, stepping in to buy at a key technical level.
And now the change in momentum is luring human traders, too. It might take weeks to months, but Facebook stock will recover from this. Investors are too hungry for growth at FB’s price to ignore it.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
