Roughly 15 months ago, Facebook (NASDAQ:FB) stock saw the largest one-day loss of market value in the history of worldwide stock markets. After the company’s second-quarter 2018 earnings report, Facebook stock dropped 19%. Its market capitalization fell a stunning $119 billion in a single trading session.
Facebook’s numbers for last year’s second quarter admittedly weren’t great. But they weren’t terrible, either. Earnings per share came in 3 cents better than the average Street estimate. Top-line growth did disappoint. But revenue still increased 42% year-over-year, only 1.2 points lower than consensus projections.
What sent FB stock plunging was the company’s outlook going forward. The social media firm projected lower revenue growth. More concerning, owing to privacy issues and other factors, management guided that 2019 expenses would increase at a faster rate than the top line.
The combination of slowing growth and compressing margins spooked investors. FB stock has never really recovered. To be sure, it’s bounced nicely, gaining over 44% in 2019 alone. But Facebook stock still sits about 10% below the all-time highs reached the day of that Q2 release.
The 2019 performance explains why that is. And ahead of the company’s third-quarter 2019 earnings report on Wednesday, it’s 2020 expectations that will have to change that fact.
Do Q3 Earnings Matter to FB Stock?
Facebook’s guidance for 2019 has proven correct. Through the first half of the year, revenue has increased 27% YOY. That’s a notable deceleration from the 40%-plus growth posted in first half 2018.
Meanwhile, costs have soared. Even excluding a $5 billion legal accrual relating to a settlement with the Federal Trade Commission, total costs and expenses have increased 37% YOY in the first six months. Backing out that settlement, earnings still have grown. But a 14% increase in operating income is a far cry from the mid-term growth rates investors were expecting in July 2018.
Analysts at least aren’t expecting much of a change in the second half. For Q3, consensus EPS estimates sit at $1.91, 8.5% above the prior year’s $1.76. Q4 profit growth is projected to come in at less than 5%.
But next year, the Street sees growth accelerating. Full-year EPS is projected to reach $9.50, up over 50% relative to 2018 numbers. Obviously, the comparison against the $5 billion accrual this year is a factor. But even backing that out, the Street is looking for at least 18% profit growth next year.
In that context, the actual profit numbers in the third quarter might not matter all that much. Facebook likely will beat on earnings, as it has every quarter for at least five years. But a modest beat in 2019 doesn’t change the case here: upside in FB stock requires the company get back on track in terms of growth next year. This year’s spending already is known, and already is priced in.
A strong bottom-line performance won’t hurt FB stock, obviously. But investors already know that 2019 is going to be a challenging year for margins. What’s up for debate is 2020 and beyond.
Watch the Top Line
And there are two key factors to watch on that front. First will be revenue growth in Q3. The Street is looking for a 26% increase in that figure in Q3. Facebook absolutely has to hit that target for FB stock to gain after the report.
Again, cost increases already have occurred — and they’re not likely to recede. Increased headcount focused on areas like privacy and content moderation. Those problems will (unfortunately) persist. If Facebook can keep growing revenue at a fast rate, however, it can leverage that higher spend and still expand margins.
With FB stock again challenging near-term resistance that has held at $190, top-line growth might be key here. There’s some evidence that the duopoly of Facebook and Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) is starting to crack.
Independent ad-tech firms like Trade Desk (NASDAQ:TTD) and The Rubicon Project (NYSE:RUBI) have shown impressive growth — and seen their share prices soar as a result. Amazon.com (NASDAQ:AMZN) presents another threat. Twitter (NYSE:TWTR) and Snap (NYSE:SNAP) still are posting impressive top-line growth.
If Facebook can impress on revenue regardless of those competitive challenges, the case here becomes more compelling. The top-line outlook improves for 2020 and beyond. Cost concerns are mitigated, given the fact that incremental revenues (i.e., higher ad prices or more usage of the platform) hit operating profit at near-100% rates.
And at roughly 18-times 2020 consensus EPS backing out the company’s cash hoard, FB stock clearly is cheap enough to rally if optimism toward 2020 improves. Modestly lower spending in Q3 probably can’t drive that optimism. Better-than-expected revenue growth can.
2020 Is Key for Facebook Stock
Of course, Facebook itself can also impact the outlook for 2020 — by discussing the outlook for 2020. When asked by an analyst on the Q2 2019 conference call in July, CFO Dave Wehner specifically declined to give expense guidance for next year.
Management did warn listeners to expect further deceleration in revenue growth next year. But that leaves a wide range of outcomes relative to the 25%-plus growth rate expected for 2019. And it’s impossible to know at the moment whether 2020 expenses will grow at a rate similar to, or even close to, the 35%-plus likely this year.
Facebook may not necessarily give guidance on that front after the third quarter, instead choosing to wait until the Q4 report early next year. But as proven by last summer’s plunge, that guidance can move FB stock. Even a lack of clarity on that front may spook some investors, who figure that no news is bad news.
If investors come out of Q3 feeling like Facebook stock is back on track, a run to all-time highs above $210 certainly is possible. Again, FB stock is cheap enough to see its multiple expand. Anything less, however, and worries about competition taking market share and costs eating up profits return.
The options market only is pricing in a 6% move in FB this week, which seems low. This seems like a big quarter for Facebook, but for reasons that will go beyond how the company actually performed in the quarter.
As of this writing, Vince Martin has no positions in any securities mentioned.
