Will 2018 Be a Painful Year for Facebook Inc Stock?

FB stock - Will 2018 Be a Painful Year for Facebook Inc Stock?

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I’ve been bullish on Facebook Inc (NASDAQ:FB) stock for some time now, but even I am starting to wonder if FB stock might be at risk. The narrative surrounding Facebook has changed significantly, even over the past few months.

With Facebook stock now worth over half a trillion dollars after a 900%+ gain from late 2012 lows, valuation is becoming a bit stretched as well.

As such, Wednesday afternoon’s fourth quarter earnings report represents a major test for FB stock. For the first time in quite a while, there are real questions surrounding Facebook.

How will it manage so-called “fake news”? Will governments — particularly in Europe — start cracking down? And is there truly a way to drive the positive changes CEO Mark Zuckerberg argued for earlier this month without sacrificing the profit growth investors and analysts seek?

Those questions are going to be asked on the post-earnings conference call. And it’s likely the answers to those questions will do more to move Facebook stock than the Q4 numbers do. Because the concerns surrounding the stock aren’t about what happened in 2017. They’re about what’s going to happen in 2018 … and beyond.

FB Stock and the Q4 Numbers

As far as the numbers go, there’s little reason to expect anything other than another beat. Facebook has outperformed Street expectations in terms of both revenue and earnings for ten consecutive quarters despite ever-tougher comparisons. The online advertising market seems strong, and the dual dominance of Facebook and Alphabet Inc’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google unit remains unquestioned.

The largest potential concern relative to expectations is likely on the margin side. In Q3, Facebook announced plans to double the size of its security team from ~10,000 to 20,000, putting more resources toward reviewing ads and enforcing community standards. As Zuckerberg put it in the Q3 release, “Protecting our community is more important than maximizing our profits.”

The news of that spend momentarily shook FB stock after the Q3 report in early November, though it did recover. And it’s unlikely that it will be large enough, or ramped quickly enough, to have a material impact on Q4 numbers. All told, an eleventh straight beat looks most likely. But it’s worth noting that Facebook stock has underperformed since that earnings release.

Since Nov. 1, FB stock has gained just 2.3%. The NASDAQ 100 has risen 11%; the S&P 500 almost 10%. Fellow ‘FANG stocksAmazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX) have jumped 29% and 41%, respectively. Whether margin concerns are the major driver or not, it’s clear the sentiment toward FB is moderating, which raises the stakes for Wednesday’s report.

Drivers for Facebook Stock

There’s a scenario where the sentiment toward Facebook as an investment changes markedly coming out of Wednesday afternoon’s report. Facebook already has said security comes before profits. Zuckerberg is now arguing that profitability falls in the pecking order behind engagement as well.

In both cases, Zuckerberg might be right, but that doesn’t necessarily help FB stock owners. And the question has to be whether the business model is going to have to change going forward.

Keep in mind, this is a company with already staggering operating margins — 50%, as I pointed out last month. It has easily brushed off competition from Snap Inc (NYSE:SNAP) and Twitter Inc (NYSE:TWTR). But that model might be at some level of risk. Security spending is going up. ‘Ad load’ (the amount of ads shown) likely is coming down. Regulators are poking around, including antitrust authorities in Germany.

It’s not as if Facebook stock is going to collapse, but it increasingly looks like Facebook is going to have to change. But FB investors don’t want it to change: Selling advertising to nearly one-third of the world’s population on the site at 50% operating margins is a really, really good business.

So the lesson investors will take from Facebook’s Q4 report is how much management thinks the business is going to have to change. From a short-term standpoint, in particular, the more change is coming, the worse FB stock likely will perform.

If Zuckerberg and his team can convince investors that the recent changes all will work out in the end and that they will increase engagement and keep Facebook’s growth alive, Facebook could rally back to new all-time highs just above $190.

But if management doesn’t inspire that confidence — or if it doesn’t have that confidence — FB stock will suffer. And a stock already underperforming of late could be headed for an outright decline.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2018/01/facebook-inc-fb-stock-painful-year/.

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