When Facebook (NASDAQ: FB) reports quarterly earnings on July 24 after the market closes, investors may not want to expect more upside. FB stock already staged a V-shaped recovery that began in May.
After bottoming at the 200-day simple moving average on June 1 at $160, investors may already have priced in the strong quarterly profit numbers. Facebook will need to report revenue accelerating higher than thought.
Facebook’s Revenue Acceleration
Trading recently above $200, Facebook could break-out above its ~$218 52-week high if revenue exceeds the $16.5 billion and EPS estimate of $1.90.
Source: Tipranks
To get there, ad revenue from the News Feed on the Facebook site and ad impression sales on Instagram must grow. In the near-term, ad revenue may stall due to new rules around political advertising. The government has yet to update those regulations that counter election tampering from foreign nation states. Adoption of new regulations to protect consumer privacy may also hurt Facebook’s revenue in the quarter.
Facebook is also aiming to lower the number of ads shown on News Feed, promoting user-generated content over corporate advertising-driven pages. On Instagram, the company is still trying to figure out how to generate profit margins at levels that are comparable to ads sold on the Facebook News feed.
Despite the near-term challenges, Facebook started Q1 2019 with mobile ad revenue growing 30% to $13.9 billion. It benefited from growth across all regions. And its business is so broad that its top 100 advertisers account for under 20% of its total ad revenue.
With the benefit of a more diverse advertising base, Facebook stock is less risky for technology investors than last year.
Responding to Criticism
Facebook is increasing transparency in its work on elections to appease the U.S. government. It shored up defenses for the midterm elections and will do the same in other parts of the world. Ads are no longer just electoral ads but include all ads. Its users may search for and report bad ads without any difficulty.
Investors could expect higher investments in the near-term potentially hurting earnings. The company will increase its investments in tools that protect its platform from interference. This also benefits advertisers by helping them grow their business. Tools that help advertisers reach their target audience with greater frequency will bring in more business. And end-users benefit from receiving ads that are relevant to them. The more often they click the ads, the more Facebook gets paid and the happier advertisers are with their effective ads.
On the Instagram platform, Facebook introduced Interactive Stories Ads globally earlier this year. The company recognized the power of people and businesses using interactive features to start conversations on Stories. Advertisers may now use polling stickers to get noticed and to drive better results.
Checkout on Instagram is another new initiative. People who find products through a story or post may optionally buy the product without even leaving the app. Instagram counts on MAC and Addidas as some of the 23 brands implementing Checkout to their advertising strategy.
Facebook’s 2019 Outlook
Facebook forecast a deceleration in growth rates throughout this year. Headwinds related to ad targeting will have a greater impact on results in the second half of 2019. With such a negative outlook, investors who missed the entry point on FB stock at ~$160 may question the latest rally. The stock’s bounce may be due to speculation that the expense growth of 47%-55% year-on-year is higher than projected. If expenses come in closer to the prior guidance of 40%-50%, then the recent stock rebound is justified.
Even if earnings fall short of the lofty expectations, Facebook’s $17 billion-$19 billion capex forecast is still below the previous $18 billion-$20 billion range. Its commitment to focus on the core product, infrastructure, safety, security, and innovation will lift long-term operating margins. In effect, if earnings come in short of consensus later this month, investors could buy the stock to bet on long-term growth acceleration.
Valuation and Your Takeaway
Facebook still has substantial upside if investors assume that revenue will grow by at least 17%-25% annually. In a five-year DCF growth exit model from finbox.io, investors may accept a discount rate of 9.5%.
This low rate is justified: Facebook has a solid track record of delivering strong growth driven by ad sales in the last few years.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.
