Facebook Inc Stock Is Big Growth at a Big Discount

FB stock - Facebook Inc Stock Is Big Growth at a Big Discount

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I’ve been pounding the table on Facebook Inc (NASDAQ:FB) stock for a while now, saying that it is the definition of a big growth stock trading at a big discount. And while FB stock has been a winner in the long-term window, the short-term picture hasn’t been so great.

Over the past 3 months, FB is up only 3%. Amazon.com, Inc. (NASDAQ:AMZN) is up more than 20% over the past 3 months. Alphabet Inc (NASDAQ:GOOG,NASDAQ:GOOGL) is up 15% over the past 3 months. The Nasdaq-100 is up 8%.

Am I worried about Facebook stock’s relative underperformance over the past several months?

Not at all. The concerns weighing on the stock seem unnecessarily short-sighted, while the valuation has plenty of room to expand to match peer valuations. That set-up implies an exceptionally favorable risk-reward profile for FB stock at current levels.

Concerns Weighing on FB Stock Are Overblown

There are few concerns that have weighed on Facebook stock recently, and none of them hold much water in the long-term.

The first is that the new tax bill may actually weigh on the valuations of hyper-growth tech stocks like FB. The logic is that the U.S. deficit will balloon. The government will borrow a ton of money, flood the bond market, and drive interest rates higher.

That will erode the equity risk premium, drive inflation higher, and dilute the present value of “down-the-road” profits, which is where these hyper-growth stocks get a ton of their value from.

This makes sense, but it ignores the fact that these same hyper-growth tech stocks will also get a huge earnings boost as a result of the tax bill. Cowen estimates that FB will get an 8% boost to its earnings per share. Also, it is tough to see interest rates and inflation going that much higher in a world that is on the verge of automation wiping out huge swaths of the labor market.

Second, many bears correctly point out the fact that Facebook ad load is maxing out, but they incorrectly extrapolate that to mean that revenue growth will slow meaningfully over the next several years. FB is much more than just the Facebook mainstay app.

Facebook is Instagram, Messenger and WhatsApp. It also is the newly unveiled Watch, Messenger Kids and Facebook Local. Throughout this whole ecosystem, Facebook has plenty of digital real estate to load up with ads.

Third, a lot of bears are also concerned about Amazon rising as a formidable competitor to the digital advertising duopoly that is Facebook and Google.

Amazon is a rising threat in the digital advertising world, but considering that Facebook and Google have consistently reported robust ad revenue growth, I think it is more likely that ad dollars shift from smaller players towards Amazon (this trend is already happening). Facebook and Google should remain largely unscathed.

Fourth, there is a concern out there that despite Instagram’s strength, the rest of Facebook’s ecosystem of apps continues to fall out of favor with teens. But this is why Facebook just launched Messenger Kids.

I think Messenger Kids could be huge for Facebook. The logic is pretty simple. Facebook can leverage Messenger Kids to influence the 13-and-under crowd so that when they turn into teenagers, they are drawn towards Facebook’s ecosystem of apps and not towards Snap Inc (NYSE:SNAP).

FB Stock Is Really Cheap

The most attractive thing about Facebook stock is that it is really cheap.

Earnings are expected to grow around 17.4% per year over the next several years, but Facebook stock trades at only 30.4x this year’s earnings estimate. That means FB stock is trading at just a 75% premium to its growth prospects.

The whole S&P 500 is trading at a 95% premium to its growth prospects, despite those growth prospects being materially lower (20.5x this year’s earnings for 10.5% growth).

Facebook should easily trade at a similar, if not bigger, growth premium. The company is supported by a strong, secular growth narrative with multiple and diverse drivers.

There is a ton of cash on the balance sheet against no debt. Top-line growth rates are really big and expected to remain really big. Profit margins are big and growing. Cash flows are robust.

There is no reason FB stock shouldn’t trade at a 100% growth premium in this market. That implies a “fair” fiscal 2017 earnings multiple of 34.8x, which on $5.86 earnings estimates, implies a fair value of over $200.

Bottom Line on FB Stock

Facebook is big growth at a big discount. Near-term concerns are overblown, while long-term growth prospects are robust.

All else equal, there is no reason FB stock should trade under $200.

As of this writing, Luke Lango was long FB, AMZN, and GOOG.

Article printed from InvestorPlace Media, https://investorplace.com/2017/12/fb-stock-big-growth/.

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