Global internet giant Facebook (NASDAQ:FB) is slated to reported third-quarter numbers after the bell today. My channel checks suggest that the numbers should be pretty good. But, digital advertising peer Snap (NYSE:SNAP) also reported pretty good third-quarter numbers not too long ago, and SNAP stock tumbled in response.
Will FB stock follow a similar path?
I don’t think so. Instead, I think Facebook stock is positioned to move higher in the event that third-quarter numbers are strong, as they should be.
The logic is fairly simple. Given its robust long-term growth prospects, FB stock looks fairly cheap at current levels. This cheapness is a result of investors not fully believing in Facebook’s long-term growth prospects. But, strong third-quarter numbers will lend credibility to those growth prospects. Increased conviction there will wipe out the relative undervaluation in FB stock and shares should consequently head higher after a strong Q3 print.
The investment implication? There’s reason to be bullish on FB stock ahead of earnings.
Facebook Earnings Should Be Good
My channel checks suggest that Facebook earnings should be really good.
First, data from the Interactive Advertising Bureau shows that digital ad growth trends have maintained impressive strength in 2019. Digital ad spending is rising in 2019 at a similar pace to past years. Second, digital ad peers Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Snap corroborated this data, with strong Q3 revenue numbers. Each company saw its digital ad business grow faster this quarter than it did last quarter.
Third, data from Merkle shows that Facebook and Instagram sustained big ad spending growth in the third quarter. Specifically, Merkle says that Facebook ad spending rose 12% year-over-year in Q3, marking two consecutive quarters of growth acceleration after a slowdown in late 2018. Merkle data also shows that Instagram ad spending rose an impressive 44% year-over-year in Q3, roughly in line with the big growth rates Instagram has been posting all year long. Also of note, visits to brand sites driven by Facebook and Instagram were both up more than 20% in the quarter.
Fourth, Wall Street is bullish on the quarter. Multiple firms, such as Rosenblatt Securities and Barclays, have issued updates over the past month saying that Facebook and Instagram ad demand trends have remained strong, and that Facebook looks positioned to report a beat.
There are multiple data points here which, when strung together, strongly imply that Facebook will report impressive Q3 numbers.
Facebook Stock Should Move Higher
In response to strong Q3 numbers, Facebook stock should move higher, mostly because shares look undervalued heading into the print.
Consider these numbers. The global digital ad industry is expected to grow at a 12% compounded annual growth rate over the next several years. In that 12% growth industry, Facebook is the world’s second-largest player, with about 20% share in 2018. More than that, because of Instagram ad ramp, Facebook’s market share has consistently expanded over the past few years, from less than 10% in 2014. Given that Facebook still has yet to throw ads on Messenger or WhatsApp in a meaningful way, doing so over the next few years ensures that Facebook’s share expansion trajectory will persist.
The big picture idea? Facebook is a company that is consistently expanding share in a 12% growth market. That means that Facebook will remain a 15%-plus revenue growth company for the next several years. Growth could even be bigger than that if commerce or hardware initiatives gain traction.
At the same time, profit margins should rebound from today’s depressed levels, as recent big privacy investments fade and sustained revenue growth once gain kick-starts positive operating leverage.
Overall, then, Facebook projects as a roughly 15% revenue grower with upside margin drivers, and that growth profile should produce nearly 20% profit growth. Assuming so, then Facebook will easily hit $20 in earnings per share by 2025, if not sooner. Based on a historical average 20-times forward price-to-earnings multiple, that implies a 2024 price target for FB stock of $400.
Discounted back by 10% per year, that equates to a 2019 price target for FB stock of nearly $250. Shares trade hands under $200 today.
Bottom Line on FB Stock
Facebook stock appears undervalued heading into a Q3 earnings report that should be pretty good. That’s a bullish setup, and it ultimately implies that FB stock could pop after the print.
As of this writing, Luke Lango was long FB.
