As you may know, Facebook Inc (FB) stock has been on a tear this year. It’s up 37% in 2015 with about two months left to go in the year, and it’s coming off a remarkable quarter.
Importantly, FB still isn’t experiencing any of the user growth or engagement woes that Twitter (TWTR) has been going through — in fact, Facebook has been able to add and grow successful functionalities like Facebook Video pretty effortlessly this year.
FB users watched 8 billion videos a day last quarter, a figure that has doubled in the last seven months alone. Oh, and third-quarter revenue and EPS were both much stronger than Wall Street expected.
You get the picture: There’s a lot to like about FB stock. I’ll concede that.
But I also think a crucial part of being a successful investor is being honest with yourself and taking an unemotional examination of the potential pitfalls in your portfolio. By no means is FB stock immune from risk, so let’s look at three of the biggest ones facing it today:
Threat No. 1: Ad-Blocking Technology
Unlike Alphabet (GOOG, GOOGL), which has slowly but surely diversified a small portion of its revenue stream away from advertising, FB is actually becoming more dependent on ad revenue — 95% of revenue through the first nine months of 2015 was from ads, compared to 92% in the same period last year.
Clearly, that concentration seems to be working. But the growth of ad-blocking technology is no joke, and as it becomes more widespread, Facebook could begin to experience its wrath.
Facebook itself acknowledged this could threaten its business, and thus the FB stock price, in its most recent quarterly report, saying:
“…these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed.”
Threat No. 2: Valuation
This risk is certainly more a feature of FB stock than its business, and there’s very little a company can do to prevent it. When investors become irrationally exuberant — which is known to happen with momentum stocks — a stock’s price can reach unsustainable or unattractive levels.
Facebook may be flirting with those levels currently. Shares trade at a whopping 107 times earnings and 37 times forward earnings.
As investors, we are forward-looking, so I like to use the forward P/E ratio.
I acknowledge that FB stock deserves some premium to the broader market … but a multiple more than 2 times the average S&P 500 stock seems too high to me.
Price-to-sales is also absurd, clocking in at 19. No other large-cap stock even approaches that metric, the closest one being ARM Holdings (ARMH), a $22 billion company with a P/S of 15.
Threat No. 3: Its Best Growth Is Behind It
Last but certainly not least: FB’s most rapid growth is behind it. With 1.55 billion monthly active users, it will never see the sort of user growth it saw in the early going again. Mathematically, it’s impossible.
The 1,100% growth between 2004 (1 million users) and 2006 (12M users)? Never again. The 2,900% user growth between 2006 (12M) and 2009 (360M)? Definitely not gonna happen.
Even the 135% growth between 2009 (360M) and 2011 (845M) will prove tough to achieve in the next five to 10 years.
The hope is that FB’s Internet.org initiative, aimed at providing internet access to the masses across the globe, will get more users online and help foster continued user growth. But with Internet.org bringing just 15 million people online to date, that clearly won’t drive meaningful change.
What FB has to do is become better at monetizing existing users … which means its site will inevitably become more intrusive and riddled with ads as investors demand high growth.
While Facebook hasn’t had trouble delivering for its shareholders thus far, it can’t keep performance like this up forever.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at email@example.com.
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