It may seem like I am way behind the curve with this headline, but a conservative growth investor like myself needs to be absolutely certain that a growth stock is a growth stock, not a momentum play.
After this week’s earnings report, however, I think there’s enough here to make Facebook stock worth watching as a growth stock. However, it’s worth mentioning that FB is pretty outrageously priced at current levels.
Still, the earnings numbers are difficult to ignore, so I want to highlight some of the ones that caught my eye.
Facebook Stock Pros
For starters, daily active users were up 17% YOY, breaking the one billion mark. With total monthly active users of 1.55 billion, that means two out of every three users log in every day. FB has become an integral part of people’s social lives. This is a critical cornerstone as far as Facebook stock’s future. If the company can worm its way that far into people’s lives, it will be extremely difficult for them to cast it off.
As a result, we’ve learned that FB has truly become a centralized resource for online social interaction. I know that comes as no surprise to many, but a billion users is impossible to ignore, and the fact that one’s friend status on FB has taken on such a degree of social significance can’t be ignored either.
Our society is at the point where de-friending someone is the equivalent of slapping them in the face and has significant social consequences.
With all of these users, it stands to reason that advertising is where Facebook stock is generating its revenue. Indeed, mobile ads represent 78% of ad revenue, and total ad revenue hit $4.3 billion, up 45%. So, while FB and analysts consider itself to be a mobile advertising company, what underlies that concept is the idea of people coming together in a virtual environment.
Sound familiar? Starbucks (SBUX) calls itself a coffee company, but as I’ve said ad nauseum, the coffee only exists because of the underlying concept of people coming together in a physical environment.
Facebook Stock Cons
I wasn’t wowed by the 4% growth in daily active users compared to last quarter. Yes, we’re talking about tens of millions of users, but it suggests that, at some point, new active users are going to dry up. At that point, FB will have to continually add functionality it can monetize to keep up with growth.
I remain concerned over the reliance on ad revenue. Right now, advertisers are flocking to FB, and that helps Facebook stock. However, at some point, a day will come where they flock to something else. I have no idea what that might be, but it will happen, because that’s what has historically happened.
Plus we’ll be hit with another recession one day, which will drive down ad spending. That fact should be a serious concern for long-term investors in Facebook stock.
The other downside is that expenses exploded, up 68% to $3.04 billion. Those expenses crushed margins, lowering them from 44% to 32%.
Bottom Line for FB
Facebook stock generated $2.127 billion in net income through the first nine months of the year, and $2.809 billion in the trailing 12 months. With Facebook stock trading at $109, and having about $15.8 billion in net cash, or $7 per share, the effective stock price is $102. That gives it a P/E ratio of 104.
Even though growth is terrific, I cannot justify paying a price that high — especially when the future for Facebook in terms of revenue sources isn’t clear. The company is doing well, but investors have bid up Facebook stock to an insane valuation. Stay away unless it gets knocked back to reality.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was long SBUX. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
