Facebook’s (NASDAQ:FB) second-quarter earnings showed that the company’s multiple headwinds are clearly weighing on its results and outlook. Consequently, Facebook stock fell sharply in the wake of the results. Since these stiff headwinds are unlikely to ease any time soon, investors should avoid owning Facebook stock.
Negative Catalysts Hurt Facebook’s Results
As I predicted previously, the Cambridge Analytics scandal and worries about security, along with competition from Snap Inc’s (NYSE:SNAP) Snapchat, seem to be having an impact on the company’s user metrics. Facebook’s global daily active users came in at 1.47 billion, below analysts’ consensus estimate of 1.49 billion, according to CNBC.
Additionally, the company had 185 million daily active users in North America, slightly below the consensus outlook of 185.4 million. Moreover, the company’s user growth “was flat in the U.S. and Canada, and declined in Europe from the previous quarter,” Marketwatch noted.
In addition to the election scandals and competition from Snapchat, meaningfully increased advertising spending on Amazon (NASDAQ:AMZN), large retailers’ websites and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) are probably weighing on the growth of Facebook’s ad revenue. The social media giant’s Q2 revenue came in slightly below expectations, and, more ominously, it expects its “revenue growth rate to decline by high-single-digit percentages from prior quarters sequentially in both Q3 and Q4,” Marketwatch quoted FB’s CFO, David Wehner, as saying. It’s pretty difficult to be very bullish on Facebook stock as long as the company’s revenue growth is poised to fall by nearly 10% year-over-year.
The Scandals Are Causing Other Problems for Facebook Stock
As if all that wasn’t ominous enough, the scandals seem to be having more negative effects on Facebook and, by extension, Facebook stock. First of all, the scandals appear to be forcing the company to spend a great deal of money on security. During the company’s second quarter earnings conference call, Mark Zuckerberg admitted that:
“Looking ahead, we will continue to invest heavily in security and privacy because we have a responsibility to keep people safe. But, as I’ve said on past calls, we’re investing so much in security that it will significantly impact our profitability.”
Indeed, the spending on security appears to be a major factor behind a looming, significant reduction in the company’s profitability. Wehner, Facebook’s CFO, divulged that, “we anticipate that total expense growth will exceed revenue growth in 2019.”
It’s never a good sign when a company’s profitability is dropping. That’s especially true for a high tech company that should be constantly finding new ways to increase its top and bottom lines. Since Facebook isn’t doing that, many investors will probably abandon Facebook stock and buy the shares of tech companies that are finding more methods of making money.
FB’s focus on security, necessitated by the election scandals, is probably a big reason for its lack of profitable innovations. On the Q2 conference call, Facebook discussed various initiatives that could increase its profit — monetizing WhatsApp, carrying out virtual reality projects, developing new types of ads — but none of them seems close to contributing meaningfully to the company’s results. It’s a good bet that the company’s personnel is too focused on security issues to devote much of its time or effort to other initiatives.
FB Stock Still Isn’t Cheap
Nor, as many others have noted, is FB stock too cheap. With an elevated forward price-to-earnings ratio of 21 and a huge price-to-sales ratio of 11.5, nobody can say that FB stock is a bargain, especially given the company’s headwinds.
Investors should definitely sell Facebook stock and find other tech names that have fewer problems and more growth opportunities.
As of this writing, Larry Ramer did not own shares of any of the companies mentioned.