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9 In-Depth Reasons Why Facebook, Inc. Is a Must-Own Stock

Big growth plus discounted valuation equals huge gains for FB stock

By Luke Lango, InvestorPlace Contributor

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Congressional Hearings Likely Harden the Battle Lines Over FB Stock

Source: SilverIsdead Via Flickr

Facebook, Inc. (NASDAQ:FB) recently fell victim to what was arguably its worst PR incident ever after a whistle-blower exposed a data leak that happened in 2015 regarding political analytics firm Cambridge Analytica.

A few weeks later, Facebook reported what was arguably its best earnings report ever.

Facebook reported its best financial results ever against the backdrop of its worst PR incident ever. That is shocking. More importantly, it’s a testament to just how powerful and necessary the Facebook machine has become.

As such, Facebook stock has rallied off its post-Cambridge Analytica lows of $150 to trade in the $180’s. That is right around where it was trading prior to the data leak news hitting the wire.

Have you missed the rally?

Hardly. This was just a rebound. A minor blip in the overall upward trajectory for Facebook stock.

This upward trajectory will persist. Facebook stock is supported by some of the strongest fundamentals in the market, with a big growth narrative converging on a relatively discounted valuation. That creates a compelling opportunity to buy and hold FB stock for the long-run.

Facebook is so massive that it has become an integral part of how the internet functions, and it is poised not only to grow more, but to provide more services in one place — and the markets are not currently valuing it this way.

Here’s an in-depth look at why Facebook stock is a must-own here and now:

1. 2 out of 3 People Who Can Have a Facebook Account, Do Have a Facebook Account

Perhaps the most important and most attractive thing about Facebook is its size.

The social media behemoth has 2.2 billion monthly active users. The world has about 7.6 billion people, and of those, only roughly 4.1 billion have access to the internet. About 800 million of those internet users are in China, where Facebook is blocked. Therefore, the global internet population that has legal access to Facebook numbers around 3.3 billion.

Again, Facebook has 2.2 billion monthly active users. That means that essentially 2 out of every 3 people in the world that can have a Facebook, do have a Facebook account.

No other company in the world has that scale. Not Amazon.com, Inc. (NASDAQ:AMZN). Not Netflix, Inc. (NASDAQ:NFLX). And not even Alphabet Inc (NASDAQ:GOOGL) or Apple Inc (NASDAQ:AAPL).

Facebook is on its own playing field in terms of global size, reach and scale.

And that doesn’t even consider Facebook’s newly minted “Family of Apps”. Those 2.2 billion monthly active users are on the core Facebook platform alone. Facebook has another 1.5 billion monthly users on WhatsApp, 1.3 billion monthly users on Messenger, and 800 million monthly users on Instagram.

Put it all together, and that is 5.8 billion users. Granted, there is heavy overlap between users, so it isn’t 5.8 billion distinct users. But the entire Facebook ecosystem essentially acts like and has the power of a platform that has 5.8 billion combined monthly users because what matters isn’t distinct users, but rather, the number of eyeballs you capture and for how long you capture them (if a user goes from Facebook to Messenger to Instagram, that same user will have used 3 different apps, but stayed within the Facebook ecosystem the whole time).

2. Facebook Is the Internet ID

In many senses, Facebook’s massive size is its greatest asset. Because it is so big, Facebook has become an irreplaceable part of the internet.

I like to think of Facebook as the internet ID. In the physical world, everyone has a physical ID that they use to identify themselves and get into places. If you are walking into a bank, they ask for your ID to confirm identity. If you get pulled over by the cops, they also ask for your ID. And if you want to a drink at a restaurant or a bar, chances are they will be asking for your ID, too.

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Source: Shutterstock

Facebook is exactly this for the digital world. Facebook is your digital ID, complete with a profile picture, life details like birth-date and workplace, and a list of friends and recent activity. Because of this, it has all the information and data that anyone needs to identify you. Also, because everyone has a Facebook, it is a universal means for digital identification.

This is why there are so many “Login with Facebook” options across the internet.

Streaming music platform Spotify Technology SA (NYSE:SPOT) uses “Login with Facebook”. So does dating app Tinder — owned by  Match Group Inc (NASDAQ:MTCH). As do ride-sharing app Uber, rent-sharing app Airbnb, social payments platform Venmo — owned by Paypal Holdings Inc (NASDAQ:PYPL), professional networking site LinkedIn — owned by Microsoft Corporation (NASDAQ:MSFT), sports news platform ESPN (a Walt Disney Co (NYSE:DIS) property), and many, many more.

They all use this feature because: 1) it is easier, 2) everyone has a Facebook, 3) is it arguably more secure, and 4) Facebook has all the data in the world that any of them need in order to get started on creating a personalized account for new users. It doesn’t matter that Facebook is in direct competition with some of these companies. That’s how vital Facebook has become.

From this perspective, it is easy to see how Facebook’s size and data have allowed it become to the internet’s ID. In doing so, Facebook has become part of the underlying fabric of the internet.

Moreover, because Facebook’s database is so large, the company has indeed become an irreplaceable part of the internet. Facebook has relevant information data on more than 2 billion people globally. Until another platform can rival that scale, Facebook is irreplaceable.

3. Facebook’s Size Is Also Its Greatest Financial Weapon

From a financial perspective, Facebook’s size is so important for two reasons: 1) unparalleled reach and 2) unparalleled targeting abilities. All advertisers want is the most bang for their buck, and that means max reach with max engagement. Facebook is the only platform that maximizes both due to its size.

On a raw basis, its 2 billion-plus user base is unrivaled, and naturally, Facebook offers the most global reach for advertisers. On a deeper lever, Facebook has a lot of data on 2 billion people-plus, and can use that unparalleled database to create unparalleled targeted advertising solutions. Thus, Facebook’s size allows it to offer advertisers max reach with max engagement, a combination which has allowed Facebook to dominate other social media peers in the digital advertising space.

Moreover, Facebook’s size makes it a successful imitator. Case and point: Instagram Stories and WhatsApp Status. Snap Inc (NYSE:SNAP) was killing Facebook for several years and teens were ditching Facebook and flocking to Snapchat. Then, Facebook cloned Snapchat’s core feature, Stories, and put it into its app ecosystem.

The net result was that because of the initial size of Instagram and WhatsApp, Instagram Stories and WhatsApp Status became huge hits. Now, Facebook is behind the two largest Stories platforms in the world.

Facebook’s size allows it do this replication in essentially any space, and be successful in doing so. That is why Facebook Dating poses a meaningful threat to Match Group Inc (NASDAQ:MTCH), and why Facebook can jump into almost any business that it wants to.

4. Facebook User Growth Is High in Low Internet Penetration Markets

A lot of folks are concerned that the growth in Facebook’s user base has stalled out. While the numbers support this slowing growth trend, I don’t think it’s fair to say that Facebook is done growing its user base.

User growth has come down from 30% to 20% to 15% and lower over the past several years. But that is simply a result of the law of large numbers. Once you get to a point where 2 out of every 3 internet users is on your platform, user growth is naturally going to slow.

Source: Shutterstock

But don’t underestimate the global internet growth narrative.

Roughly 95% of the entire North American population is on the internet. That is a maxed out market. As such, Facebook’s US & Canada monthly user base grew by only 3% last quarter.

Europe also has a pretty high internet penetration rate of 85%. That is also a maxed out market. Not surprisingly, Facebook’s Europe monthly user base growth was also weak. It grew just 7% last quarter.

Everywhere else, however, is a completely different story.

Asia’s internet penetration rate is below 50%, while Facebook’s Asia-Pacific monthly user base grew by an impressive 22% last quarter.

In other parts of the world, the internet penetration rate is right around 50%, which is why Facebook’s Rest of World monthly user base grew by 12% last quarter.

Overall, what we see is not too surprising. In markets where internet penetration is high, Facebook user growth is slow, around 3-7%. But in geographies where internet penetration is still low and growing, Facebook user growth is still strong, in the 10% to 20%-plus range.

5. Facebook Could Hit 3 Billion Users Soon

On a global scale, it looks Facebook still has a ways to go in terms of user growth.

The global internet penetration rate is just 55%, miles below North America’s rate of 95%. Presumably, internet usage globally is only growing, and that 55% global rate will continue to grind higher towards 95%. As that happens, Facebook’s total addressable market will expand. If Facebook can maintain its share in that growing market, then Facebook’s user base could easily keep growing at a healthy rate for the next 5-10 years.

How much bigger can it get?

Well, it is unlikely global internet penetration rates hit North America levels, but a 70% rate seems achievable in 5-10 years. Assuming global population heads towards 8 billion, then that would imply 5.6 billion global internet users, including China. Assuming Facebook maintains a roughly 53% penetration rate among global internet users (including China), then you are looking at nearly 3 billion Facebook users in 5-10 years.

And that doesn’t even include the billion-plus users on WhatsApp and Messenger, and the nearly billion users on Instagram. Thanks to global internet expansion, those numbers will head higher, as well.

6. Messenger and WhatsApp Give The Advertising Business a Lot of Unused Firepower

User growth through global internet usage expansion is a promising growth driver for Facebook stock going forward.

But it isn’t the only one.

Indeed, Facebook stock’s explosion in 2015, 2016, and 2017 from $80 to $180 was largely driven by a ramp in monetization trends. Namely, Facebook started monetizing Instagram, and that added extra firepower to average revenue per user (ARPU) growth.

For the longest time, Facebook wasn’t making any money from Instagram. It was just a platform with a ton of users but not many ads and not much money running through the system.

Then, in 2015, Facebook decided to get serious about putting ads on Instagram and making money from the platform. I remember the initial gut reaction from users was: “Ugh! More ads? I’m going to stop using Instagram so much.” But that never happened. Because the ads were non-intrusive and actually relevant (thanks to the company’s huge database), nobody quit Instagram. Instead, the platform’s user base has nearly tripled since then from 300 million to 800 million.

Meanwhile, Facebook started making a ton of money off Instagram.

Between 2011 and 2014, Facebook’s domestic ARPU grew at a 41% rate from roughly $3 to roughly $9. During that same stretch, global ARPU grew at a 27% clip from roughly $1.40 to around $2.80.

Once Facebook started seriously monetizing Instagram in 2015, everything changed. For the better.

From 2014 to 2017, Facebook’s domestic ARPU grew at a 44% rate to nearly $27. Global ARPU, meanwhile, grew at a 30% clip to nearly $6.20.

In other words, despite dramatically increasing scale and tougher laps, Facebook’s unit monetization growth actually accelerated in 2014-17 versus 2011-14.

Why? Instagram.

Now, the Instagram ad ramp is largely in the rear-view window, but Facebook is still sitting on two other, much larger platforms that have yet to be monetized in Messenger and WhatsApp. That means Facebook stock has two Instagram-like catalysts still in the pipeline.

Facebook has barely monetized these platforms so far. Right now, Messenger only has ads on the contact list, which are unintrusive to the point that many users don’t register them. (Facebook’s most recent earnings mention Messenger as a component of ad revenue, but don’t spike out the individual numbers for the app.)  WhatsApp has no ads.

Thus far, management hasn’t figured out the ideal way to monetize on a messaging app, whether it be through ads or social commerce or anything else. Eventually, though, management will figure this out. At that point in time, Facebook will start making big bucks from Messenger and WhatsApp.

Financially, that means that ARPU, although it is really big right now, could get a lot bigger. If so, Facebook stock could explode higher.

7. Watch & Workplace Are Big Growth Drivers for Facebook Stock

Up until this point, this article has focused exclusively on Facebook’s advertising business and why that business isn’t going to slow anytime soon. As a result, Facebook stock should head higher even if Facebook was just its advertising business.

But it’s not.Facebook stock has been hammered, falling 20% from the highs it made just last month. While hard to do, it's time to start nibbling FB stock.

Facebook is building out multiple nascent hyper-growth businesses that could one day be huge contributors to both the top and bottom lines. The sum of these businesses not only strength the fundamentals supporting Facebook stock, but also add significant longevity to Facebook stock’s growth narrative.

First, there is Facebook Watch. Facebook launched Watch in mid-2017 after it become crystal clear that streaming on-demand entertainment was the way of the future. At that time, Netflix was just carving up the traditional cable industry, and there was a massive shift happening from the cable model to the streaming model. As such, Facebook launched Watch to get into this space.

Watch hasn’t made much of a splash just yet, but again, it is only matter of time before Watch scales into something meaningful. After all, Facebook does have the largest potential streaming audience in the world (2 billion-plus users) and a whole bunch of cash on the balance sheet. Thus, once Facebook appropriately deploys its massive amount of resources to developing and/or acquiring content, Facebook will be able to stream that content to the largest on-demand, streaming audience in the world.

Considering how much money Netflix is making in the streaming world, Facebook Watch could easily morph into a huge money-maker for Facebook stock.

Second, there is Facebook Workplace, which is a highly undervalued part of the Facebook business. Workplace is the social network’s enterprise edition. It’s essentially a cloud-based communication tool designed for businesses of all sizes. And, it’s exactly like Slack, the hyper-growth start-up which has made a killing selling enterprise communication tools.

Formerly known as Facebook at Work, Workplace debuted in October 2016 to very little fanfare. Most investors have since forgotten about it. But Workplace scored a big win last year by signing on the world’s biggest employer, Walmart Inc (NYSE:WMT). And that will likely be only the first in a series of major wins for Workplace as enterprise social networking goes mainstream (IDC expects the ESN market to grow at a 19% clip annually to $3.5 billion by 2019).

Facebook makes money off of Workplace by charging a subscription fee. At $3 per month per user for premium, Workplace could easily scale into a material revenue stream for Facebook if the ESN market gains momentum over the next several years.

8. Marketplace & Native Payments Are Bigger Growth Drivers for Facebook Stock

Beyond Watch and Workplace, there is Facebook Marketplace. Much like Watch, Marketplace has been around for a few quarters, but hasn’t made much of a splash just yet. But also like Watch, it really is only a matter of time before Facebook turns Marketplace into something big.

As it stands, Marketplace looks like a digital garage sale of 2 billion-plus potential buyers and sellers. That model makes sense, but isn’t a complete version of what Marketplace could be. It will eventually morph into a place that accommodates those 2 billion-plus buyers and sellers, while also making room for official retailers to sell goods to a targeted group of buyers (yet another use-case of Facebook’s massive database). In this sense, Marketplace could one day scale to be the place for all e-commerce transactions.

Along the same lines as Marketplace, Facebook is rolling out native payment capability across its ecosystem. Pretty soon, “Buy Now” features will be common across all of Facebook. Imagine you see an advertisement, and that ad interests you.

Currently, there is a decent amount of friction in the process of turning that interest into financial action. You have to click that ad, likely veer away from Facebook, open another window, enter separate payment and delivery info, so on and so forth.

Source: ©iStock.com/kravcs

In the future, Facebook will add capability which removes those frictions. You will be able to store your payment and delivery info within the Facebook ecosystem, so that if you see an ad on Instagram or Facebook that interests you, you are literally just a few clicks away from turning that interest into financial action.

This capability at scale could be huge for Facebook. Facebook could take a commission off every sale that happens through its platform, much like a payments processing company does. If so, Facebook could make a ton of money off people buying and selling directly through the Facebook ecosystem. Facebook could also charge higher rates for its digital real estate in a world where they reduce commerce friction, thus adding even more firepower to the already super-charged advertising business.

9. The Street Underestimates Facebook’s Growth

To recap, Facebook’s size gives the company perhaps the biggest moat in the world, while also enabling the company to replicate essentially any business at scale. Further, Facebook’s advertising business is on fire, and the future monetization of social conversation apps Messenger and WhatsApp mean that the ad business still has a ton of firepower. Meanwhile, Facebook is developing multiple nascent hyper-growth businesses like Watch, Workplace, Marketplace, and native payments, the sum of which could add meaningful contributions to the financials over the next 5-10 years. 

Put that all together, and I really don’t understand why the Street thinks revenue growth is going to slow all the way to 25% next year, versus nearly 50% last quarter. Yes, I understand the law of large numbers. Growth is supposed to slow with scale.

But that hasn’t happened at Facebook. Revenue growth last quarter was nearly 50%. In the year ago quarter, it was also nearly 50%. Two years ago, it was a hair over 50%. Three years ago, it was a hair under 50%.

Why, then, is Facebook’s revenue growth going to all the sudden plummet to 25% after spending multiple years right around 50%?

Law of large numbers? The company has defied that trend for a while, and revenues are still less than $100 billion. Google has revenues in excess of $100 billion, so I really don’t see law of large numbers kicking in just yet.

Muted user growth? Maybe. But global internet usage expansion should keep user growth healthy in the 10%-plus range, and that level of growth led to 50% revenue growth this past quarter. That trend shouldn’t change any time soon.

Instagram ad ramp is over? Again, maybe. But also unlikely. Judging by Snap’s recent results, Instagram is kicking Snap’s butt, and that means a ton of teen-oriented ad dollars are flowing into Instagram. Plus, Messenger and WhatsApp still have yet to be monetized.

Digital ad business is nearing saturation? Again, maybe, but unlikely. And largely irrelevant. By the time the ad business does near saturation (after WhatsApp and Messenger have been fully monetized), the other businesses like Watch, Marketplace, and Workplace will be the big growth drivers.

Overall, then, I really don’t see why Facebook’s revenue growth is slated to come off the rails over the next several years. The biggest growth drivers remain strong, and there are more growth drivers in the pipeline. As such, it looks like Facebook stock will continue to benefit from successive beat-and-raise quarters over the next several years.

How Much Is Facebook Stock Worth?

Given that last quarter’s 50% growth rate has been consistent for the past several years and there are big growth drivers still in the pipeline, I don’t think revenue growth will come down by all that much over the next several years. At around $100 billion in revenues, I do expect law of large numbers to start kicking in. I also expect ad revenues to slow some as Facebook and Instagram start to get maxed out. But the overall growth rate will remain robust.

All things considered, I think this is a 30% revenue growth company per year over the next 5 years. I also think that operating margins will stay high in the 50% range thanks to robust demand for the company’s ad products. That combination leads me to believe that FB can earn around $18 per share in 5 years.

A market-average growth multiple of 20-times forward earnings on those $18 earnings implies a four-year forward price target for FB stock of $360. Discounted back by 10% per year, that equates to a fair value for FB stock of above $240.

Bottom Line on Facebook Stock

FB stock is a case of big growth converging on a discounted valuation. That convergence normally results in significant share-price out-performance in a multi-year window.

That is exactly what will happen over the next several years with Facebook stock. As such, this is a must-own stock for investors with a long-term horizon.

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


Article printed from InvestorPlace Media, https://investorplace.com/2018/05/in-depth-facebook-stock-must-own/.

©2018 InvestorPlace Media, LLC