3 Risks That Could Take down Facebook Inc Stock

FB stock still is a buy but there are potential traps ahead in 2018

By Vince Martin, InvestorPlace Contributor

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The run in Facebook Inc (NASDAQ:FB) continues. Facebook stock saw a bit of a dip starting in late November, declining 7% in seven trading sessions. But buyers have stepped in once again, and FB stock trades at yet another all-time high. After gaining 53% in 2017, Facebook stock already is up 6%+ in 2018.

I’m not terribly surprised by the gains of late. I recommended investors buy the dip in early December, and I’ve been bullish on FB for some time. But with FB stock closing in on $200, I do think at some point the gains will have to slow, if not reverse. Valuation is starting to get more aggressive, and earnings growth is expected to decelerate sharply in 2018.

Facebook remains a buy, to be sure. But upside expectations probably have to be moderated. Investors will need to watch FB stock more closely this year, and keep an eye out for these three key risks.

The Reputational Risk to Facebook

As a platform, Facebook is heading into murky waters. The platform was used to spread “fake news” during the U.S. presidential election campaign. In Europe, regulators are threatening fines if sites like Facebook, Twitter Inc (NYSE:TWTR), and Alphabet Inc (NASDAQ:GOOGL) unit Google don’t pull down more content more quickly.

The concerns here aren’t overblown. CEO Mark Zuckerberg himself has set a 2018 goal of “fixing” the platform and ensuring that “time spent on Facebook is time well spent”. But those efforts put Facebook in a difficult situation, as Josh Enomoto detailed back in 2016.

It’s a fine line between removing hateful and incorrect posts and preserving some level of free speech. In fact, it’s also a very different line in Europe than it is in the U.S.

Facebook has to walk the tightrope between removing ‘bad’ content and keeping ‘good’ content, even though individual users may see those two categories very differently.

It’s not an issue that’s going to blow up Facebook’s business by any means. But with 1.8 billion users already, and the U.S. market likely close to saturated, Facebook can’t afford to alienate users if it wants to maintain earnings growth.

Earnings Pressure

There’s another issue with the more aggressive content monitoring: it costs money. Zuckerberg himself said in Facebook’s Q3 release that “we’re investing so much in security that it will impact our profitability. Protecting our community is more important than maximizing our profits.”

Indeed, earnings growth is expected to slow down markedly in 2018. Analysts project a 38% increase in EPS in 2017 and just a 13% rise this year.

Revenue growth may slow as well. Concerns about “ad load” have swirled around Facebook stock for some time and so far haven’t had an impact. But Facebook is running out of room, literally and figuratively, to deliver ad space in the news feed.

To be sure, Facebook has plenty of options to expand its ad inventory, and its move into video is a step in that direction. But it’s not hard to imagine growth concerns revisiting FB stock in 2018.

Margins may be pressured by investments in monitoring content, data centers, and video. Weaker tailwinds from user growth and ad inventory should lead revenue growth to slow. If that combination looks likely to persist for the long-term, the narrative around Facebook stock will change – and not for the better.

Facebook Outside of Facebook

One solution to the concerns surrounding the namesake Facebook platform would be for the other business units to start contributing to revenue and profits. Instagram contributed in Q3 to ad impression growth but that figure was just 10%, with pricing driving most of the revenue increase. WhatsApp and Messenger offer limited, if any, contributions to the fundamentals.

That should change going forward, eventually. Zuckerberg and his management team certainly have earned the benefit of the doubt, and some patience. But if the legacy platform growth slows and the other products don’t add as much as helped, that, too, could send Facebook stock lower.

FB Stock Is Worth the Risk for Now

Even with those risks, FB stock remains a quality investment. But the margin of safety is getting smaller. Backing out its ~$13 per share in net cash, FB now trades at over 26x earnings.

It’s an attractive multiple in the context of long-term growth potential. Still, it’s not as compelling as the low-20s figure on offer for much of 2017. As I’ve often pointed out in the past, FB stock was valued similarly to stocks like The Coca-Cola Co (NYSE:KO) and Procter & Gamble Co (NYSE:PG), despite a markedly superior growth profile.

And the multiple raises the risk that 2018, at least, may be choppier than 2017. Guidance coming out of the Q4 report will be closely watched. Lower revenue and/or lower margins than expected could provide some short-term pressure. I’m certainly not expecting another 50%+ run in Facebook stock this year.

There’s still more than enough to stay long; as I pointed out last month, no company in the world has the combination of revenue growth, margins, and balance sheet strength that Facebook does. Increasingly, however, the market is pricing those attributes in. And at some point this year, that price may have to come down if only for a short time.

As of this writing, Vince Martin has no positions in any securities mentioned.


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