Facebook (NASDAQ:FB) stock popped after the social media giant reported second-quarter earnings which easily smashed expectations and were accompanied by a strong third-quarter guide.
In the big picture, Facebook’s strong earnings confirm that this is a winning company, strongly weathering a near-term downturn in the digital advertising market, and perfectly executing against some very big long-term growth opportunities.
In sum, then, Facebook’s strong earnings confirm that FB stock is a long-term winner.
This long-term winner is trading at a huge discount to fair value.
By my numbers, Facebook stock could rally up to $300 over the next six months.
Here’s how that could happen.
Strong Earnings for Facebook Stock
Facebook’s second-quarter earnings report was very strong, in that it delivered everything investors were looking for, and more.
You got meaningful user growth acceleration as consumers stayed at home during the quarter and played on their phones and computers. Daily active user growth hit 12.5% (versus a trailing four-quarter average of 9.1%). Monthly active user growth hit 11.9% (versus a trailing four-quarter average of 8.3%). Both of those marks were the highest since the first quarter of 2018.
You got big engagement growth on the business side. There are now over 180 million businesses who use Facebook’s tools to connect with consumers, and 9 million active advertisers.
You got a much faster revenue recovery than expected, as the economic activity and consumer spending quickly bounced back in Q2. Following steep declines in ad revenue in March, Facebook saw ad spending trends improve every month in the quarter. For all of Q2, revenue growth rebounded to 10%. Wall Street only expected 3%.
You also got impressive cost control and margin performance. Total costs and expenses rose just 4% year-over-year. Operating margins increased five points. Operating profits jumped 29%.
Facebook Targets a Strong Q3
And, perhaps most importantly, you got a strong guide. For Q3, management sees revenues continuing to rise at a roughly 10% pace, versus the 8% expected by Wall Street. Considering ad revenue trends will likely only accelerate in the holiday quarter, then it is quite likely that Q4 revenues rise more than 15%. Thus, a faster-than-expected recovery in digital ad spending and Facebook’s impressive platform resilience amid boycotts will force analysts to up estimates, a dynamic which should boost investor sentiment and FB stock.
All in all, Facebook’s earnings report was strong. How strong? Strong enough that investors should stick with Facebook stock here and now.
Huge Long-Term Growth Opportunities
Looking out over the next few years, Facebook has some huge growth opportunities.
First, there’s the global rollout of Instagram Reels, Facebook’s copycat TikTok feature, which could do to TikTok in 2020 what Instagram Stories did to Snap (NYSE:SNAP) in 2016.
Instagram Stories ended up powering an immediate uptick in user growth, a lagged uptick in revenue growth, a stretch of impressive double-beat quarters and huge gains in FB stock. I see Instagram Reels doing the same thing over the next few years.
Second, there is the acceleration of digital ad spending.
Presumably, because the novel coronavirus has accelerated the consumer adoption of all thing, digital ad spending trends will accelerate over the next few years, creating a rising tide which lift all boats in the digital ad market, Facebook included.
Third, there is under-monetized real estate on Stories, Messenger and WhatsApp.
Facebook Stories and Instagram Stories are just starting to monetize with ads. There’s plenty of room for Facebook to throw more ads into Story Reels. Concurrently, Messenger and WhatsApp are a pair of billion-user apps that aren’t being monetized. Over the next several years, Facebook will likely throw at least some ads onto those platforms, thereby increasing its market share in the expanding digital ad market.
Fourth, there’s the e-commerce opportunity.
Facebook has a unique and compelling opportunity to leverage its unparalleled reach to turn everyday social interactions, into directed business-to-consumer interactions and create an enormous e-commerce platform. Facebook Shops is a promising early development in management attacking that opportunity.
There’s just a ton of potential in the Facebook story. Enough that FB stock looks very undervalued today.
Facebook Stock Is Undervalued
Following Facebook’s earnings report, I’m reaffirming my long-term assumptions on Facebook.
Those assumptions include:
- Facebook continues to expand global digital ad market share at a cadence of roughly 100 basis points per year, to nearly 30% market share by 2025.
- Ad revenues grow at a 12%-plus pace into 2025.
- Facebook Shops grows to control 5% of global e-retail transactions in five years.
- Other revenues, powered mostly by e-commerce, scale meaningfully to $20 billion by 2025.
- Total revenues rise at a 15%-plus pace to $180 billion by 2025.
- Positive operating leverage drives operating margins back to roughly 40%.
- Earnings per share grow to $20 by 2025.
Social media stocks typically trade at 20 times forward earnings. A 20 times multiple on $20 in 2025 earnings per share implies a 2024 price target for Facebook stock of $400.
Discounted back by 8.5% per year, that implies a 2020 price target for FB stock of nearly $290.
Thus, I see Facebook stock rallying up to almost $300 over the next six months.
Bottom Line on Facebook Stock
Facebook stock is a long-term winner. Second-quarter earnings confirmed as much. The valuation, meanwhile, remains attractive, with significant upside catalysts on the horizon.
Connecting the dots, FB stock is a strong buy here. I suspect shares will be trading closer to $300 by the end of the year.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long FB and SNAP.