It’s Time to Double Down on Facebook Stock

When looking at FB stock, you need to forget all the privacy issues and focus on its cash generation

Could Facebook Stock Hit $220 and Beyond? Here's How The Trade War Helps

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Call me crazy, but if I told you a year ago that Facebook (NASDAQ:FB) would undergo a correction that would see Facebook stock lose almost 30% of its value in less than three months, you would have told me I was smoking some of Canada’s legalized pot.

Think about it.

How does a company generating $17.5 billion in free cash flow from $40.7 billion in revenue lose 30% of its value in less than three months when the economy is humming?

If I told you that I had an investment with FCF growth of 400% over the last four years and a FCF margin of 43%, that trades at a reasonable 27 times FCF, you’d ask how you could buy some.

Yet here we are with Facebook stock struggling to find buyers.

FB Stock and Instagram’s Upside Potential

InvestorPlace’s James Brumley recently discussed how an improved Instragam could be Facebook’s savior.

“Facebook doesn’t offer up a great deal of detail about where its revenue comes from,” Brumley wrote Oct. 15. “KeyBanc Capital Markets analyst Andy Hargreaves offered up some estimates, however, and believes roughly 15%, or $2 billion of the previous quarter’s $13 billion worth of advertising revenue was supplied directly by Instagram.”

If you extrapolate the 15% contribution to advertising revenue over all of 2017, Instagram generated approximately $6 billion to Facebook’s top line out of $40.7 billion.

He goes on to suggest that Instagram’s ad revenue in the second quarter grew 177% compared to no growth for legacy Facebook. According to Brumley, it’s possible that Instagram could account for 33% of the company’s overall ad revenue by 2020.

So, even if Facebook’s legacy business doesn’t grow ad revenues, it could still have $60 billion in overall revenue by the end of 2020, a growth rate of 22.5% annually.

There’s nothing terrible about that.

However, that doesn’t begin to address the potential FCF growth Instagram has over the next few years.

If Instagram’s ad revenues continue to grow by more than 100% annually over the next few years, FCF will most certainly balloon to at least $24 billion … likely more.

Facebook stock currently trades at 26 times its 2017 FCF. At the end of July, FB stock was trading at 36 times FCF. If its share price were to go sideways for the next two years, it would sell at 19 times FCF.

Assuming it can sort out its privacy issues, and that’s questionable, a multiple of fewer than 20 times FCF for a company that converts more than 40 cents of every dollar of revenue into free cash, is some nuts.

The Bottom Line on Facebook Stock

At the end of September, I called FB stock the best of the S&P 500 stocks losing ground in 2018. It’s down another 5% since then.

“While I have no idea of knowing how Mark Zuckerberg feels about paying a dividend, I do know that FB has repurchased $5.1 billion of Facebook stock in the first six months of 2018, almost three times the amount that it bought back in all of 2017.” I wrote Sept. 25. “Since Facebook stock has reached its lowest level since April, I’d bet the farm that FB will buy back more than $5.1 billion of Facebook stock in the second half of 2018.”

Facebook feels its stock is a buy, and so do I.

Given the potential cash flow generation of Instagram, I find it hard to believe that one of the most profitable companies in the index is not worth more than $157.

Call me crazy, but it’s time to double down on Facebook stock.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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