At the end of July, Facebook (NASDAQ:FB) recorded the biggest single-day drop in stock market history when the company reported soft Q2 numbers alongside an even softer guide.
Ever since then, Facebook stock has struggled. After the big post-earnings drop dragged shares to $170, FB stock rebounded quickly to $185. But, that rally didn’t last. Now, Facebook stock is closing in on $160.
This is the stock’s lowest level since the Cambridge Analytica scandal. At $160, Facebook stock is also trading at just 21x forward earnings, versus a five-year average forward earnings multiple of 33x . And, the stock is 25% off its recent high, which marks the biggest correction FB stock has seen in five years.
But, are things really that bad at Facebook? Does FB stock really deserve to trade at multi-month lows, with a far below-average valuation, and be in the midst of its biggest sell-off in five years?
I don’t think so. Things at Facebook aren’t that bad, and I fully expect the company to blow estimates out of the water next time they report. At that point in time, sentiment should normalize, and Facebook stock should move higher.
Facebook Still Dominates Digital Advertising
Everyone is concerned about two things when it comes to Facebook. First, there is falling engagement on the core Facebook platform. Second, regulation could stunt Facebook’s ability to use data to optimize ad solutions.
But, neither of those concerns seem all that bad to me.
With respect to core Facebook engagement falling, this is true, and it has been true for a while. But, core Facebook engagement is falling because Instagram engagement is rising. Facebook owns Instagram, so saying Facebook is losing because users are going from Facebook to Instagram is like saying Walmart (NYSE:WMT) loses when shoppers go to Sam’s Club instead of Walmart. As long as users remain in the Facebook ecosystem, that is all that matters.
Inevitably, users will remain in the Facebook ecosystem. There are six social media apps with 1 billion or more users in the world. Facebook owns four of them (Facebook, Messenger, WhatsApp and Instagram). Facebook is the largest app in the world. Messenger and WhatsApp are the largest mobile communication apps in the world. Instagram is the largest photo-sharing app in the world. And, WhatsApp and Instagram are the largest Stories apps in the world.
Thus, so long as ad dollars flow into the digital channel (which is an inevitable consequence of engagement going digital), Facebook will win.
With respect to regulation stunting Facebook’s ability to use data to optimize ad solutions, this is happening across all of digital advertising. Facebook isn’t being disadvantaged relative to Google (NASDAQ:GOOG), Twitter (NYSE:TWTR), or Snap (NYSE:SNAP). If one gets regulated, they all get regulated, so the playing field within the digital advertising field will remain level.
The risk here is that such regulation will stunt growth across the entire digital-advertising industry. That won’t happen. Ad dollars follow engagement, and engagement is only becoming increasingly digital. Thus, unless we all stop using our phones and go back to watching cable, the digital-ad industry will continue to see a massive influx of dollars.
In the big picture, then, Facebook still dominates the digital-advertising industry due to its four billion-plus-user apps. Therefore, so long as ad dollars continue to flow into the digital space (which will inevitably happen), Facebook stock will win.
New Growth Areas Are Promising for Facebook Stock
Another big problem with Facebook stock is that the company lacks revenue diversity. Specifically, Facebook gets essentially all of its revenue from digital advertising, so the company is entirely reliant on this tailwind continuing.
While that tailwind should continue, investors don’t like that reliance. That is why Facebook stock trades at just 21x forward earnings next to 40%-plus revenue growth last quarter.
But, Facebook is diversifying. Most importantly, the company is leveraging its social media dominance to get a foot in the door in the e-commerce space. While Facebook Marketplace wasn’t a big success, Facebook is trying again with an Instagram standalone shopping app. This should be successful because Instagram has growing engagement and a visual-first format which lends itself well to digital commerce.
Thus, Facebook is necessarily attempting to diversify its revenue streams. Those diversification efforts will eventually pay off, and Facebook will become much more than just a digital advertising giant.
Under Promise, Over Deliver
Facebook stock has been depressed recently mostly because a dour guide is weighing on investor sentiment. On the last conference call, Facebook management called for both meaningful margin compression and a revenue growth slowdown in the back half of the year.
But, Facebook management has a history of under promising and over delivering.
I think history will repeat itself here. Facebook guided weak because of the shift in monetization focus from the tried-and-true News Feed format to the still nascent Stories format. But, everywhere I look, Stories engagement on Instagram, WhatsApp, and even Facebook/Messenger is growing immensely. Thus, I don’t think Facebook will have any trouble monetizing on the Stories front.
If that’s true, then next quarter’s numbers should blow estimates out of the water. The guide should also come in above consensus expectations, too. A healthy double-beat-and-raise quarter should normalize sentiment on Facebook stock, and send shares markedly higher.
Bottom Line on FB Stock
Facebook stock is hugely undervalued because perception is that this company can’t thrive with falling core Facebook engagement. That perception is wrong, and misunderstands the scope of Facebook’s four billion-user apps ecosystem.
In the big picture, Facebook still dominates the digital ad industry, and that industry is still growing at a robust rate because engagement is only becoming more and more digital-centric.
As such, Facebook stock will be a winner in the long term. Near-term issues will get resolved with what should be a double beat Q3 earnings report, and this stock will get back to its winning ways.
As of this writing, Luke Lango was long FB and GOOG, and may initiate a long position in TWTR within the next 72 hours.