FANG killed it this quarter. Social media leader Facebook Inc (NASDAQ:FB) smashed analyst estimates thanks to FB stock’s robust ad revenue growth on top of healthy margin expansion. Retail leader Amazon.com, Inc. (NASDAQ:AMZN) also smashed expectations due to continued strength in the e-commerce business as well as continued dominance in the cloud space.
Meanwhile, Netflix, Inc. (NASDAQ:NFLX) reported really strong subscriber growth numbers which easily breezed past analyst expectations. Alphabet Inc (NADSAQ:GOOG,NASDAQ:GOOGL) bounced back from a European Commission fine-plagued second quarter to report perhaps its best earnings of the year.
But not all stocks are treated equally. AMZN stock and GOOG stock rallied big after their reports, while FB stock and NFLX stock dropped.
The NFLX drop makes sense. NFLX stock had rallied big into the report. It became a classic “sell the news” event. NFLX stock was depressed for a few days, but then it bounced back.
The FB stock price drop makes less sense. FB stock had not rallied big into the report. It wasn’t a classic “sell the news” event. Instead, investors got jittery about increased security spend adversely affecting profitability in the future.
Those jitters are overdone, and the selloff is unnecessarily short-sighted. And the FB stock price is headed for $200 soon.
Why Increased Security Spend Is a Great Thing for Facebook
Facebook CEO Mark Zuckerberg emphasized safety and security over profitability on the company’s most recent earnings call. With his company finding itself on Capitol Hill and on the wrong side of headlines regarding fake news, this emphasis was a smart move.
But Zuckerberg and fellow senior management at Facebook went further than just emphasizing safety and security. They actually said expenses would rise a lot more next year than initially anticipated due to increased investment in safety and security.
That was a brilliant move.
Investors didn’t appreciate it (FB stock sold off because it implies a less rosy margin growth outlook going forward), but the move sets a gold standard for transparency in the digital advertising world, evades a government crackdown (and potentially billion-dollar fines), and will inevitably attract more advertisers to the platform.
Companies are becoming increasingly concerned about the placement and return on investment of their ads. YouTube came under fire earlier this year for ads appearing next to extremist content. Papa John’s Int’l, Inc. (NASDAQ:PZZA) doesn’t want its ads aired with NFL games anymore, as management believes the Papa John’s brand is being damaged by the national anthem protests that are plaguing the NFL’s popularity.
Moreover, CNBC ran an article recently which highlighted major ad measurement discrepancies between Facebook and outside sources.
All in all, the biggest risks to the secular Facebook growth narrative were safety and transparency.
But huge investments into safety and security significantly mitigate those risks. With those risks mitigated, Facebook’s revenue growth runway now looks longer than ever. Why? Because as these big security investments help transform Facebook into the most transparent digital ad channel in the world, more and more advertisers will flock to the platform.
FB Stock Has a Lot More Upside
From a numbers standpoint, this all means that FB’s 47% revenue growth rate last quarter won’t drop all that much over the next several years. It is very likely FB continues to achieve revenue growth north of 20% per year into the foreseeable future.
That revenue growth should easily flow into 20% annualized earnings growth. The S&P 500 index is trading around 19.7 times 2017 earnings for 10.7% growth potential over the next several years, implying the market is trading at more than an 80% premium to its multiyear growth potential.
Apply that 80% premium to Facebook. You get a “fair” price-to-earnings multiple of about 36. A 36-times multiple on 2018 earnings estimates of $6.60 implies a one-year price target of over $235.
Bottom Line on FB Stock
It’s big growth at a big discount. Investors are concerned that some of that growth came off the table with increased security investment, but I argue such investment just lengthened the growth runway.
As such, I’m a buyer of FB stock at these levels. I think this stock easily has another 30%-plus upside over the next 12 months.
As of this writing, Luke Lango was long FB, AMZN, GOOG, and NFLX.
