Is Facebook (NASDAQ:FB) an undervalued tech giant set to catch up with its peers? Or has Covid-19 dealt it a unique blow? Investors are thinking about that question in the wake of Facebook’s modest performance in 2020; while Facebook stock is up this year, its shares have trailed many of its closest rivals.
Indeed, while Facebook has climbed meaningfully in 2020, its shares are down nearly 15% from their recent highs. That seems fair, as it’s facing some real challenges at the moment.
Facebook gets a ton of advertising from local businesses due to its unusually well-targeted advertising options. But many of these local businesses no longer exist. Facebook also gets a large chunk of advertising from travel companies, event providers, restaurants, etc. These industries have been disrupted and won’t come back overnight.
2020’s Impact on Facebook
It’s no secret that the pandemic has created positive catalysts for the tech sector as a whole. However, the impact of these catalysts has been much stronger on certain companies than on others. To some extent, the pandemic has helped Facebook by increasing the usage of its social networks. Still, though, Facebook’s primary business is advertising, and it has some customers that have been badly hurt by the pandemic.
In general, advertising businesses do not do well during recessions. It’s a testament to Facebook and Google’s (NASDAQ:GOOGL) excellent business models that their financial results haven’t been hit much harder. Still, it’s not fair to compare Facebook to Zoom Video (NASDAQ:ZM) or Fastly (NYSE:FSLY).
Even if Facebook has more users than other companies, until its advertisers’ revenue rebounds, the social media giant’s overall ad revenue growth will still be modest. And we have proof of that. Earlier this year, Facebook reported its slowest quarterly revenue growth since going public.
Facebook’s Valuation in a Post-Covid World
I’m not convinced that the value of Facebook has grown significantly this year. And that’s fine; Facebook is a high-quality company with an excellent balance sheet and high cash flows. However, the company’s share price has advanced much faster than its earnings.
At this point, Facebook is trading at 32 times its 2019 earnings and analysts, on average, expect its earnings per share to climb 20% this year. If that pans out, the stock is still downright cheap now. However, the analysts may be a tad optimistic.
Consider that Facebook’s revenue has only increased 20% annually in recent years. Now its earnings growth has fallen below that level because the company has had to hire thousands of people to regulate controversial content on its platforms. Going forward, I expect Facebook’s revenue growth to slip as the Facebook website continues to stagnate, and the weak economy make a lasting impact on part of the firm’s customer base.
It’s not hard to envision Facebook’s EPS growth rate falling to 10%-12%, particularly as the aging Facebook platform continues to lose younger users. Buying the stock of a company with 11% earnings growth and a price-earnings ratio of 32 isn’t terrible, but it’s not an especially wonderful deal either.
I’m happy to hold onto my Facebook stock now. But I’m waiting for the shares to dip toward $210 or $220 per share before considering buying more of them.
The Verdict on Facebook Stock
Facebook remains my favorite tech stock with a market capitalization of $500 billion or more. It’s fun to give the company grief for its namesake platform which is over-the-hill and decidedly uncool. And Facebook’s management has made a fair share of missteps as well, while the pandemic has certainly impacted the advertising sector. Add it up, and it’s not hard to be bearish on Facebook stock.
I disagree with that line of thinking though. While the Facebook platform has its problems, I’d argue that Instagram’s incredible growth more than makes up for that. Plus, the company has plenty of other things cooking, including WhatsApp and its virtual reality efforts.
I also think that Facebook CEO Mark Zuckerberg deserves more credit than we give him. The Instagram acquisition was one of the finest capital-allocation decisions of the past decade. And he made that deal despite tremendous criticism of it at the time. Almost everyone (certainly myself included) thought it was nuts to pay a billion dollars for a company with a dozen employees and no revenue. But look at Instagram now.
There is plenty that could go wrong. None of the FAANG stocks — including Facebook — is a sure thing at their current valuations. Huge revenues and profits today doesn’t necessarily ensure future success.
The tech graveyard is full of companies that once had great platforms but became complacent. So far, however, there’s no sign that Zuckerberg has lost his ability to be a ruthlessly effective leader. And as long as that is that case, Facebook stock should perform quite well. Just watch the stock’s price;, there’s a chance that you will be able to buy the shares for a cheaper price in the near future.
On the date of publication, Ian Bezek held a long position in FB stock.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.