Facebook Inc (NASDAQ:FB) touched a new high last week following solid earnings results from Microsoft Corporation (NASDAQ:MSFT) and Alphabet Inc. (NASDAQ:GOOG, NASDAQ:GOOGL). Chances are good that the social networking giant will also beat market expectations, sending the stock higher.
After all, price multiples between the two online advertising giants are similar. Facebook’s P/E is 40 times, while Alphabet trades at a 38 times multiple. And markets rightly bet that Alphabet’s advertising business would grow.
Facebook’s mission of building communities, growing mobile and innovating Instagram will add meaningfully to third-quarter results.
Facebook’s Communities
Facebook reported 2 billion people used Facebook every month in the second quarter. Over 1.3 billion users visited the site daily. This led to revenue growing an astounding 45% to $9.3 billion.
Facebook has earned its success for a number of reasons. It built communities such that they are meaningful enough to bring people together. Having a real-world support structure bridging with the social networking space is unique in the online world. It has over 100 million people as members of these groups.
Facebook’s implementation of Instagram Stories is paying off. Though it may “borrow” the functionality and features of Snap Inc.’s (NYSE:SNAP) “My Story,” on Instagram, 250 million people used it every day in Q2.
Investors may see FB stock move higher as the company applies Stories to WhatsApp, yet again raising daily usage on the messaging app. Both WhatsApp and FB Messenger continue Facebook’s objective of building communities.
Eventually, it will have a business ecosystem that centers on the instant messaging apps.
Growth in Mobile
In Q2, Facebook’s revenue on mobile grew an impressive 53% year-on-year, to $8 billion. It now makes up nearly 90 percent of total growth revenue. It clearly has a moat in serving video and static ads to users on devices.
Whereas on the desktop, where users may install ad blockers, few ad-blocking add-ons and browsers exist. Facebook’s desktop ad revenue grew just 17 percent. Growth could have slowed even more had the company not put an effort to limit the impact of ad-blocking technologies. So mobile is a clear path for ad revenue growth.
And Facebook is still maximizing the effectiveness of ads as users spend even more time on mobile. Advertisers know it too: Instagram has 15 million business profiles while 70 million are on Facebook.
The company improved its Dynamic Ads by opening it up to more business sectors. Last quarter, Delta Air Lines, Inc. (NYSE:DAL) ran ads to people who visited its site. Those who searched for a flight but did not book one were served an ad. This brought users back to the site so that they would complete their flight booking.
Worries for FB stock
Facebook supported the high revenue growth rate with higher expenses. Expenses rose 33% in Q2 to $4.9 billion. It increased its staff count by 43%, to over 20,000 employees. Investors should expect hiring growth rates to continue in the upcoming quarter.
Investors may also worry about two things. First, Facebook’s expense growth will settle in the range of 40% to 45%. As long as revenue growth exceeds expense growth, investors will be happy.
Second, monetizing the popular WhatsApp chat app could happen sooner, but the company is in no hurry to introduce ads that alienate its user base.
But neither of these worries is enough to justify selling FB stock at this time.
Facebook is a well-run company whose sites have a strong moat against Snapchat or even Alphabet’s Google. Higher costs may weigh on profits in the third quarter, but the investments will pay off to make sure growth in the years ahead.
As of this writing, Chris Lau did not hold a position in any of the companies mentioned.
