Facebook Inc (NASDAQ:FB) doesn’t look ready to break out of its slump soon now that its News Feed is under attack for the role it played in the election. The fact that FB stock just broke a key technical level doesn’t help matters any, either.
Facebook, Twitter Inc (NYSE:TWTR) and Alphabet Inc (NASDAQ:GOOGL) are all coming under fire for their roles in letting fake news and hate speech come further into the forefront ahead of the 2016 presidential election. While each is taking steps to alleviate the matter, Wall Street isn’t taking much notice.
Facebook stock will eventually consolidate and change course, but traders and tactical investors might have to wait a while for the reversal. The fears that sparked the initial selloff in FB before the election are only getting worse now that the social network’s News Feed is under pressure to rid itself of fake news.
The current downtrend in FB stock started Nov. 8 with its quarterly earnings report. Facebook spooked the market by telling investors to expect slower growth 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:
“As 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 news feed growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully.”
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.
That’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%.
FB Stock Still a Long-Term Buy
Facebook is reluctant to take more responsibility for its News Feed because of the effect it will have on its ad revenue. Taking a heavier hand on the editorial side of what passes for news would be the responsible move, but it would cost FB at a time when the feed is already becoming less profitable.
However this all shakes out, though, FB stock will still have an outsize growth forecast, and that’s something investors will always pay a premium for once some of the smoke clears.
Investors are willing to pay 22 times forward earnings for Facebook stock. 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 outsize growth rate would warrant a higher price-earnings ratio. If Facebook’s top-line expansion is slowing down, then by all means the name needs to suffer a little multiple contraction.
But the current low P/E is really overdoing it.
Consider that even at Facebook’s more “poky” growth rate, revenue is forecast to increase by 35% next year. True, multiples and revenue projections don’t run in tandem, but a 40% drop? That’s too much for a company expected to build its top line like that.
Valuation reverts to the mean, but only over time. As always, long-term investors need to ignore short-term stumbles, of which there certainly could be more.
Facebook Stock Chart
Click to Enlarge FB stock failed to find support at its 200-day moving average. It’s possible shares won’t find support until the most recent low in the high $90s or even their 52-week low in the mid-$90s.
The relative strength index shows Facebook stock as being borderline oversold and not really to the degree where you would expect a reversal. The MACD indicates the trend remains to the downside.
Facebook bulls are going to have to have faith through what could prove to be a tough few months for the stock.
But it’s still a long-term holding.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.