It’s been a whirlwind couple of months for Facebook, Inc. (NASDAQ:FB). The stock hit its all-time high in February at $195/share. Then the Cambridge Analytica scandal hit. Facebook stock ended up dropping to as low as $150 within the next two months. After CEO Mark Zuckerburg’s congressional appearance in early April, however, the tide started to turn.
Later that month, Facebook blew away earnings expectations, and the stock surged. Now, Facebook stock is back up around $193 and within reach of fresh all-time highs and the important $200 psychological level.
So, was Cambridge Analytica a non-story? No, that’d be the wrong takeaway. However, FB stock wasn’t all that expensive prior to the Cambridge scandal and became downright cheap as things played out. So now that the buzz has cooled and the stock has recovered, what happens next for Facebook stock?
Don’t Let the Slippery Slope Scare You
A common tactic in debating is the so-called slippery slope argument. If one bad thing happens, it will lead to another and another, and soon you’ve careened into a death spiral. However, it’s a logical fallacy, not a legitimate form of argument. Just because one thing occurs doesn’t mean everything else has to follow. Business isn’t a game of dominoes.
Facebook stock bears have created a slippery slope of their own. They suggest that the Cambridge Analytica scandal will lead to media scrutiny. That leads to enhanced government regulation. Fines and lawsuits follow. After that, users #DeleteFacebook and advertisers flee the platform.
Then earnings start to drop, the PE multiple compresses, and FB stock collapses. However, nothing that bad is likely to happen.
Realistically, How Bad Is Facebook’s Situation?
You may have noticed a flood of emails from companies and advertisers over the past couple weeks. That’s due to GDPR, Europe’s new General Data Protection Regulation. GDPR went into effect at the end of May. It codifies stricter policies regarding collection of users’ personally identifiable data and gives people the explicit ability to revoke consent and opt out of data collection.
The effects of GDPR remain to be seen. Privacy activists are suing Facebook in Europe on GDPR-related grounds. However, as the flood of emails over the last month shows, this regulation affects most internet operations, hardly just Facebook.
In fact, one of the rules of capitalism is that dominant companies tend to prefer regulated environments. Regulation adds a barrier to entry, making it harder for startups to overtake the existing powers. While Facebook has a black eye from the Cambridge Analytica scandal, it is large and powerful enough to overcome it.
However, the new laws that go into effect to prevent a recurrence of that sort of thing are likely to slow down the rate of innovation on the internet, helping companies like Facebook and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) stay on top of the heap.
Facebook Stock Is Heading to $200+
FB stock bears argue that the company is overvalued now. Their reasoning goes that Facebook was trading around $185 before the Cambridge Analytica story broke. FB stock is now trading higher than it did prior to the scandal. And the scandal hurt Facebook’s image. Thus, the stock is seriously overpriced.
I disagree. Political risk has long been a key element of Facebook stock. I warned of it as early as last fall. Sure, the details that came out recently painted an even uglier picture.
But anyone following Facebook closely knew it had serious political risk many months ago. Oftentimes, you need to get those concerns out into the public, as we did when Zuckerburg testified before the Senate, to reset the narrative around the stock.
Now everyone is well aware of the political risk, and the market has decided Facebook is still worth bidding up to new all-time highs. And with good reason. The stock was really cheap due to the scandal, selling at 16x forward earnings at one point. That’s simply crazy for a company that is expected to grow earnings at 26%/year compounded over the next five years.
Strong Earnings Overshadow Everything Else
Facebook’s most recent quarterly earnings results blew away expectations. Not only did they top both revenues and EPS estimates by a wide margin, they reset the narrative on the stock more generally.
For example, the company grew revenues at a 49% year-over-year rate in Q1 2018. That’s exceptional. It was their highest revenue growth rate out of the past four quarters. If anything, Facebook’s growth is accelerating.
That is in stark contrast to the predictions that Facebook had largely finished monetizing mobile for its flagship site and that users would start deserting the platform.
Facebook’s management also confirmed that it’d seen little sustained user losses after the Cambridge Analytica scandal. Also, they noted that very few major advertisers abandoned the platform in the wake of the bad press.
Now to be certain, Q1 contained just a couple of weeks from after when the scandal hit. Q2, by contrast, will be the first quarter that is fully exposed to potential downsides from the negative scrutiny.
Further social data, such as Google Trends searches, seem to indicate that the #DeleteFacebook movement disappeared pretty quickly, though. I expect Facebook to impress again in Q2, putting aside any lingering concerns about the company’s post-scandal future. And, with those results, Facebook stock should top $200/share, if it isn’t there already by then.
At the time of this writing, the author owned FB stock and had no positions in the other aforementioned securities. You can reach him on Twitter at @irbezek.