FB Stock: Is Facebook Inc a Buy After Stellar Q2?

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Facebook Inc (NASDAQ:FB) continues to ride from success to success. Shares are now up nearly 600% from the lows hit in 2012. FB stock has enjoyed an exhilarating climb over the past four years. Facebook managed the transition to mobile advertising flawlessly and acquired Instagram at just the right moment.

FB Stock: Is Facebook a Buy After Stellar Q2?

The company’s winning streak continued with its most recent earnings release. The company smoked expectations, showing huge gains in both revenues and profits.

However, FB stock has soared since 2012. With the company’s market cap now crossing $350 billion, can the company justify its enormous valuation?

FB Stock Pros

Business Scaling Profitably: Many internet companies struggle to ever become significantly profitable. While revenues rise and rise, without profits, share prices tend to lag. Facebook does not suffer from this problem.

In its most recent quarter, Facebook grew revenues at an enviable 59% clip. The even better news is that costs only grew at a 33% rate. That means that it costs Facebook very little to serve more ads. Once the underlying network is in place, it can be scaled at low cost. That difference between revenue growth and costs allowed net income to grow a stunning 186% from the same period last year. Facebook has resolved the question of profitability; its business model is now proven and increasingly successful.

Great Advertising Platform: Much of the internet media industry is in shambles. Many companies are laying off employees as advertising revenues failed to meet expectations. Increasingly, it looks like only Alphabet Inc (GOOGL, GOOG) and Facebook have really figured out how to monetize mobile. As long as Facebook has a big edge in mobile, it will continue to garner a growing portion of the online advertising share.

Amazingly, mobile advertising now constitutes 84% of Facebook’s overall ad revenues. Most online sites are nowhere near that. Facebook truly nailed the mobile transition, and it has a sizable competitive edge from that victory. Combined with Facebook’s almost omniscient level of knowledge about its users, the company should have no problems continuing to grow advertising in coming quarters.

Instagram Booming: Facebook’s namesake site has experienced some issues with user engagement. Fortunately, Facebook has a potential solution in-house. Instagram continues to grow rapidly. This offers it another meaningful avenue for the company to reach consumers who tire of Facebook itself. Instagram now tops 500 million monthly users and a particularly impressive 300 million of those are active daily users. That 500 million user base is up from 400 million in less than a year.

Some analysts estimate that Instagram will outproduce Twitter Inc (NASDAQ:TWTR) in advertising revenues as soon as the end of this year. While many people mocked Mark Zuckerberg for paying $1 billion for a 13-employee firm in 2012, that purchase turned out to be right on the money. Instagram is a huge growth factor in Facebook’s overall plans.

FB Stock Cons

Expensive Stock: Unfortunately, the FB stock price already factors in these positive developments. Shares hit new all-time highs following earnings, and they’re far from cheap. The company is now trading at around 60x earnings. On other measures, it is equally expensive. Facebook trades at a princely 16x sales, and 7x book value.

Additionally, FB offers no capital return for shareholders — it pays no dividend and currently buys back no shares. In fact, it continues to issue new shares. The total number of shares outstanding is likely to cross 3 billion soon. That’s up from just 2.2 billion at the end of 2012. FB stock will work out okay for investors if the company’s torrid growth continues, but there’s no backstop here to insulate shareholders if anything goes wrong with the company’s trajectory.

Tax Shelter Problems: Facebook delivered great Q2 results. However, a new tax liability threatens to take some gloss off the results at least in the near-term. Back in 2010, Facebook shifted its global operations out of the U.S., relocating them in Ireland. That country is one of Europe’s leading tax havens, offerings very low corporate rates.

However, the long arm of the IRS caught up with the company. Facebook’s latest 10-Q reveals that the IRS is going after the company for back taxes from 2010 onward. Facebook reported that it could represent a $3 billion to $5 billion charge, plus accumulated interest. While the amount of money at stake isn’t devastating for a company of Facebook’s size, it’d still be a meaningful setback, costing them several dollars a share in liability plus perhaps a higher effective tax rate going forward.

Platform Losing Stickiness? Sharing data over the past year paints an unpleasant vision for Facebook’s future. The number of users regularly posting updates continues to decline. There’s less and less organic engagement with the company’s flagship site. Also, younger users seem disinterested in Facebook. To the extent those users end up on Instagram, that’s not a huge problem, however other competitors such as SnapChat loom large.

Facebook benefits greatly from network effects. The more users it has, the more nonmembers will feel compelled to join. However, this can also run in reverse. As some users start to leave, the site will lose relevance for the remaining members. Facebook’s transition away from traditional bread-and-butter, family-and-friends-orientated content toward celebrities, live videos and so on may garner some excitement initially. But it threatens to erode the very personal community that made the site a hit originally.

Verdict for Facebook

Facebook is experiencing tremendous growth. However, this is well-known. FB stock is making new all-time highs. Facebook is now the world’s fifth-largest company by market cap. The company trades at an extremely premium valuation.

If the 60% revenue growth rate continues, FB stock buyers will make healthy returns.

But if Facebook’s user engagement problems continue to mount, or the online advertising space experiences a significant shake-up, things could go south in a hurry.

At the time of this writing, Ian Bezek had no positions in any stocks mentioned. You can reach him on Twitter at @irbezek.

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Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2016/08/buy-facebook-fb-stock-earnings/.

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