Regulatory Scrutiny May Affect Facebook Stock Price

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Year-to-date, Facebook (NASDAQ:FB), the social media and digital advertising titan, is up about 40%. Facebook’s current ecosystem includes Facebook mobile and desktop, Instagram, WhatsApp and Messenger. Despite increased volatility and uncertainty in broader markets, FB stock has released relatively strong earnings in recent quarters.

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Meanwhile, over the past year, there has been a shift in the global political environment. Now more countries are calling for tougher regulation of the technology giants, including Facebook. Long-term investors are wondering what they should expect from FB stock’s fundamental metrics as the company gets dogged by data privacy issues.

I do not think it will be easy for the FB stock price to keep impressing shareholders in the final months of the year.

August FB Stock Price Has Fallen

On July 24, Facebook stock released second-quarter earnings. Investors paid special attention to several metrics.

Facebook’s digital advertising business is the main revenue generator and the social network has a lucrative business model. Facebook stock as well as Google’s parent company Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) have a combined share of the U.S. digital ad market duopoly that stands well over 50%. In Q2, Facebook’s revenue came at $16.89 billion, an increase of 28% year-over-year. About 98% of FB stock’s top line comes from ads.

Daily active users: Facebook management said that the DAU number has now reached 1.59 billion, an increase of 8% year-over-year. In other words, FB stock’s most recent DAU number is approximately 20% of the global population. Facebook users are not only individuals, but also institutions, businesses of all sizes and organizations, including workplaces, community centers, schools and even places of worship.

Ad impression growth: In Q2, the number of ad impressions served across the group’s services increased 33%. Ads on Instagram stories and feed as well as Facebook’s newsfeed were the main drivers. In other words, through the data collected on its platforms, Facebook can allow for a specific target to be reached via focused demographics, interest and a number of other criteria. Rich and reliable data, of which FB has plenty, is at the center of digital advertising.

On July 24, prior to the release of the quarterly results, FB stock closed at $204.66. The next day, Facebook share price saw a 52-week high of $208.66. Since then, FB stock has been declining and is now hovering around $187.

Concern Over FB Stock’s Decreasing Margins

When investors see any sign of weakening profit margins, they become concerned. During 2019, Facebook’s average price per ad has been in decline.

In Q2, despite the impressive growth in ad impressions, average price per ad further declined 4% year-over-year. Ideally, Facebook should not monetize stories or feeds at lower rates. Going forward, investors are likely to pay close attention to this metric.

Analysts have also noted that FB’s rising costs have been pressuring margins lower over time. Prior to the release of Q2 earnings, Facebook reached a record-breaking $5 billion settlement with the FTC. Management said that due to this cost, FB stock’s Q2 earnings per share were significantly lower than anticipated. EPS came in at 91 cents, versus the consensus number of $1.74.

InvestorPlace readers may remember that in March 2018, the Cambridge Analytica controversy put Facebook in the limelight. Since then, a plethora of privacy issues as well as alleged violations have been in the news regularly.

In July 2018, management had already said that Facebook’s profit margins would likely decrease for several quarters because of the costs of improving privacy safeguards and due to slowing usage in the advertising markets.

The Q2 report further showed how FB stock’s profit margins took a hit, due to the legal expenses and fines regarding the FTC privacy investigation. Now Facebook’s operating margin stands at 27%. It was 44% in the same quarter a year earlier.

More Regulatory Headwinds

During the Q2 earnings call, Facebook said the company is still under investigation by regulators. In July, the U.S. Department of Justice announced an antitrust review of several online platforms, including FB. In early September, Google shareholders realized how fast stocks can fall when the talk of a regulatory probe gathers pace.

Investors are now rightfully concerned that due to these regulatory headaches, FB stock’s revenue growth could come under even more pressure in future quarters.

Believers in FB stock highlight the fact that there are no real alternatives to the company. Although other platforms such as Twitter (NYSE:TWTR) and Snap (NYSE:SNAP) offer a way to connect socially, they are not as popular or comprehensive as Facebook. Therefore advertisers are drawn to FB’s ecosystem. And for investors, FB stock has been a clear winner over time and in 2019.

Nonetheless, it is worth remembering that since March 2018, FB stock has not really changed and is still around $187. So if you had been a buy-and-hold investor in Facebook stock, your FB portfolio would not have changed much at the end of the past 18 months.

If regulatory risks continue well into 2020 or beyond, they might end up overshadowing any strong earnings results Facebook may have.

In other words, the current price level may actually continue to act as resistance for Facebook stock unless these privacy issues are settled fully.

The Bottom Line on FB Stock

Facebook stock has a strong story and the company has a clean balance sheet with no debt. Thus it remains a long-term growth play on a fundamental basis. Going forward, Facebook is likely to successfully leverage its network for further sales and earnings growth. I also expect the group to make concentrated investments in privacy and security measures to alleviate regulatory and investor concerns.

However, there will likely be increased stock price volatility in the near term. As the recent quarterly results show, FB stock’s costs have unexpectedly risen. And the Facebook share price has taken a hit in the past few weeks.

If you aren’t already long Facebook stock, you may want to remain on the sidelines in September as near-term trading is likely to be choppy.

If you are an investor who follows technical charts, you will note that the $190-level has become a resistance area. In the early weeks of this quarter, I expect FB shares to trade within a range of $175-$190.

If you already own Facebook shares, then you may want to stay the course and ride out any short-term volatility.

Alternatively, those investors who have benefited from Facebook stock’s 2019 gains may want to take some of the paper profits.

Or you may consider hedging your positions. As for hedging strategies, covered calls or put spreads with Oct 18 expiry could be appropriate as straight put purchases are likely to be expensive due to heightened volatility.

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

Tezcan Gecgil, PhD, began contributing to InvestorPlace in 2018. She brings over 20 years of experience in the U.S. and U.K. and has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Publicly, she has contributed to investing.com and the U.K. website of The Motley Fool.


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/regulatory-scrutiny-may-affect-facebook-stock-price/.

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