Facebook (NASDAQ:FB) has had a great year, rising over 20% so far in 2020, and up over 68% from its bottom in March. But Facebook stock could rise further as this may not be the end of its trajectory. Earnings growth is expected to exceed 33% next year, taking Facebook along with it.
For example, 49 analysts polled by Yahoo! Finance expect earnings per share (EPS) to reach $7.93 this year, up 23% from last year. That puts Facebook stock on a forward price-earnings (P/E) ratio of 33 times earnings.
That might seem expensive. But keep in mind that the average estimate for next year is $10.10 from 48 analysts. That puts the stock on a much cheaper 25 times P/E ratio.
This is well below its historical average P/E ratio, according to Morningstar. In the past five years, the adjusted average P/E has been 32.5 times earnings. In other words, the stock is 30% undervalued. That is why I think Facebook stock will rise at least 30% over the next year.
Q2 Earnings At Facebook
Barron’s Max Cherney reported that after its earnings release for the second quarter on July 31, Facebook isn’t fazed by the ad boycott against it. Over 3 billion people are now monthly users of Facebook and its other platforms.
Facebook pointed out several times in its earnings call that its ad revenue comes mostly from small and medium-sized businesses. Those businesses are less likely to join a boycott. Why? They place ads to gain exposure to the billions of users on Facebook. That is, in effect, why its growth will continue fairly surely over the next year.
Earnings came in much higher than expectations. As a result, the earnings predictions I mentioned earlier were reaffirmed.
Keep in mind this company makes massive amounts of free cash flow. For example, in the past 12 months, it has generated approximately $18.8 billion in free cash flow. That represents 25% of its $75.2 billion in sales over the past year. This is an impressive FCF margin.
Over the past year, its cash balance has grown almost $10 billion from $48.6 billion to $58.2 billion. At this rate its cash balance could easily hit $100 billion in several years. That would represent 13.9% of its $712 billion market capitalization. That would be the case, unless, of course, the stock did not rise.
My point is that Facebook stock will fly higher, not just from earnings, but from higher levels of cash it is able to pile up from FCF growth.
What Should You Do With Facebook Stock?
I suspect that, short of another deep coronavirus-induced recession, Facebook stock will likely rise by at least 30% over the next year. This is because its earnings and FCF growth will rise by roughly that amount. Moreover, investors will likely give the stock a similar 33 times P/E ratio as in the past.
Therefore, this seems like a pretty good investment to make as long as you try to increase your stake in the stock when it gets cheaper.
In that regard, I almost hope that the boycott movement makes the stock cheaper. The reason is that Facebook has a very strong user and ad revenue base. This is the kind of temporary problem that could provide a buying opportunity in Facebook, especially if the movement gains steam. Of course, that is also my contrarian streak coming out. I always look for reasons to buy out-of-favor companies that have strong fundamental business economics.
By the way, some analysts already think this boycott is having an effect. Seeking Alpha reported that Morgan Stanley analyst Brian Nowak said Facebook’s ad revenue growth was just 10% in Q2 compared to the firm’s expectation for 15% growth. Nowak attributed the difference to the effect of the boycott.
I suspect that if this feeling grows, it could make Facebook stock an even better buy over the next year. In the end, this is a superior, profitable company, with excellent prospects and a reasonable valuation given its growth.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
