Facebook Inc (NASDAQ:FB) continues to make a mockery of its skeptics. For years now, we’ve heard that Facebook is going to slow down. And yet, as InvestorPlace contributor Chris Lau put it, FB stock still is a “High-Growth Engine“. The company’s earnings grew 49% in the most recent quarter; that’s amazing for a company that is already so large.
With success, however, comes the chance of excessively high expectations. Facebook stock is up more than 32% on the year.
While bulls are right that the company is firing on all cylinders, its stock is priced as such. Will FB continue to grow into its stock price, or will some of the company’s negatives trip the stock up?
FB Stock Cons
Original Programming Is Risky: Until recently, Facebook seemed uninterested in making its own content. Instead, it continued to rely on user and partner-generated content. That fit with the company’s original ethos of connecting friends (and the occasional advertiser).
However, Facebook has now changed course. It will now be working with content creators such as Buzzfeed and Vox Media to create 20 to 30 minute original shows. Obviously, this approach has been highly successful for some. Netflix, Inc. (NASDAQ:NFLX) has sold a lot of subscriptions based on House of Cards and other blockbuster shows.
However, the scene may be getting crowded at this point. With Amazon.com, Inc. (NASDAQ:AMZN), Snap Inc (NYSE:SNAP) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) all competing aggressively here as well.
Facebook has copied features from peers with success over the years. But this one may too late. And I’m not sure its a good fit for their core platform, as it dilutes the central purpose of using Facebook’s service.
Stock Is Expensive: Facebook continues to be an amazing growth story. However, the market has fully figured that out. FB stock has made a procession of new all-time highs throughout 2017. As soon as something good happens, people bid the stock up a few more points. For the year, Facebook stock is already up more than 30 bucks per share. Chasing after a big move always comes with risk.
At this point, it is trading at 40x earnings, and a rather ambitious 25x EV/EBITDA ratio. Yes, it’s fairly normal for internet companies to trade at 30x earnings and 15x EV/EBITDA, but FB is well beyond that.
If any company is going to grow into its valuation, it’s probably going to be Facebook. But realize that you need a few more years of solid in-line earnings growth merely to justify today’s FB stock price, let alone pave the way for much more upside.
Core Platform At Risk: While Facebook is doing great things with Instagram, Whatsapp, and other side projects, its core platform is at risk. The company has, at least in my view, been diluting the addictive properties that made its namesake property such a success.
Almost every year, there are more ads, more generic mass media content, and less stuff from friends and family. People are sharing less and less now that employers, attorneys, exes and so on can use the site for research. And younger folks increasingly view Facebook as stodgy. The company risks becoming a utility, like LinkedIn, rather than being an integral part of peoples’ lives. Facebook’s move toward impersonal video only threatens to accelerate this switch.
FB Stock Pros
Beating Snap: Snap went public with a great deal of fanfare. However, the euphoria turned to gloom following Snap’s disappointing quarterly results. SNAP stock has bounced back a bit since that fateful Q1 report, however, the company’s outlook still looks fairly cloudy.
What is causing Snap so much trouble? To put it simply, Facebook’s ability to copy their new stuff. Whenever Snap debuts some solid new feature, Instagram tends to match it shortly thereafter. Thus, new feature announcements, such as Snap’s custom group stories from last week don’t garner much excitement. FB can do it equally well if it catches on with users. While I’m skeptical of Facebook’s original content strategy, by contrast, their competitive moves against Snap have worked perfectly.
Outstanding Growth: As I argued above, FB stock is priced for rapid growth going forward. But even the skeptics can’t argue with its track record. Facebook has been an earnings monster.
In 2012, FB made $5 billion in sales and earned a paltry 1% net margin, earning just $53 million in net income. It looked like an unproven business model at that point. But no one is saying that anymore. Over the past 12 months, Facebook did more than $30 billion in sales. Even more impressively, its profit margin has soared: it earned $12 billion in profits, turning more than a third of those sales into profits.
Perfect Balance Sheet: Facebook has never operated with leverage. The company has shunned debt since going public. However, in 2012, Facebook maintained a cash balance of less than $10 billion. This figure has exploded over the years. The cash balance topped $30 billion earlier this year.
What will Facebook do with the money? At this point, we don’t know. They can use it to keep making acquisitions to head off upstart competition. They can invest internally. If they don’t find compelling investing opportunities, they can always buyback stock or even initiate a dividend. Bears like to argue that FB stock will eventually fall out of fashion. However, with $30 billion and rising in the bank, management will have plenty of options to evolve with changing consumer tastes.
Verdict on Facebook Stock
FB stock is one of the leading tech stocks of this generation. Anyone that has ridden the stock since the IPO has now made a fortune. And most signs continue to point upward. The company has a growing war chest, several popular and growing apps, and a leading advertising business model. However, Facebook stock has surged just as quickly as the business’ performance, and U.S. tech stocks are up a ton as a sector. Feel free to keep riding the momentum, but know there will probably be a sharp profit-taking rally at the first sign of earnings weakness.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned stocks. You can reach him on Twitter at @irbezek.
