It’s been a surprisingly quiet year for investors of Facebook (NASDAQ:FB) stock. Shares are up just 26%, lagging far behind Apple’s (NASDAQ:AAPL) 54% rise and Tesla’s (NASDAQ:TSLA) eye-popping near-400% gain. How did FB stock, a supposed winner of the work-from-home movement, get left behind?
Actually, the company has been keeping up just fine.
In the second quarter, Facebook blew Wall Street’s expectations out of the water. Revenues beat estimates by 7.4%, per-share profits by 22.7% and daily user growth by roughly 3%.
These are staggeringly large beats for a $750 billion enterprise. And as the company weathers the 2020 election and coronavirus pandemic, shareholders will quickly realize one thing: that Facebook has become a spring-loaded stock.
Investors, get ready for a great comeback for Facebook stock in 2021.
FB Stock: Undervalued, Unloved and Ready to Shine
While you’ll usually find me reporting on smaller tech companies that can grow 10x to 1,000x, Facebook deserves a special mention during these extraordinary times. The company, which also owns Instagram, Messenger and WhatsApp, has been a massive coronavirus pandemic success story.
Facebook’s shares have lagged, but stand to rebound in 2021 as valuations catch back up
In Q2, Facebook’s revenue-per-share grew 10.2%, and profits almost doubled as advertisers shifted spending online. And it’s clear why advertisers chose Facebook in particular: the social media giant added yet another 200 million monthly active users (MAU) in 2020, bringing total users to 2.7 billion. The company now counts well over a third of the planet as actively monthly users. User engagement has also soared: 79% of active Facebook users now log in daily, an all-time high.
Yet, these gains have gone almost undetected by Wall Street. Shares have lagged other tech giants as investors have fretted about Facebook’s slowing growth and turned their attention to younger upstarts like TikTok.
A Good 2020, a Great 2021
Not only has Facebook done well in 2020. Analysts expect the company to do even better in 2021. As the overall advertising industry regains health, analysts expect Facebook’s revenue to increase by 24% in 2021. Morningstar, a financial services firm, pegs the number even higher, at 34%.
There are three critical reasons for optimism. Firstly, analysts expect overall ad spending to return to pre-pandemic growth in 2021. The extra advertising dollars will decrease competition and boost Facebook’s bottom line.
Secondly, Facebook has emerged from this summer’s political stumble relatively unscathed. In June and July, the company faced a boycott by large brands and advertisers over its lack of controls over limiting hate speech. While these walkouts could dent Q3 numbers, the company has since installed enough measures to right the ship.
Finally, the company stands to benefit from a societal shift toward social media news. And not just in the U.S. either. In India, Facebook’s largest market by users, a study by the Hammerkopf Consumer Survey found an 87% increase in social media usage during the beginnings of the coronavirus pandemic.
And here’s what that means for Facebook’s value in 2021.
What’s Facebook’s Stock Worth?
Analysts expect Facebook to grow revenues at a moderate 13.8% CAGR over the next ten years. EBIT margins are expected to increase from 42.0% to 54.5% by mid-decade.
Using these relatively conservative estimates (and projecting EBIT margins to revert to 42% by 2029), a 2-stage DCF model shows a fair value of $377/share or a 47.5% upside from today’s prices. In other words, Facebook’s underlying value has steadily marched upwards, even though its stock price has not.
What about its fast-growing tech peers? A similar DCF model using the same discount rates on Apple shows a -10.9% downside. And what about Tesla, with its 400% YTD gain? A sweat-inducing -58.0% downside.
These valuation issues show up in basic ratio analysis (a helpful guide I like to use outside of DCF models). Facebook trades for 23.6 times EV/EBIT – a high ratio, but not absurd for a software company. Apple, on the other hand, now trades for 27.0 times, a princely sum for a company that still earns 2/3 of revenues from hardware sales. And what about Tesla? The electric vehicle maker now trades at 307 times EV/EBIT, making it one of the most expensive large-cap companies in the world. In other words, Facebook remains quite cheap despite its rapid growth.
Issues at Facebook
Things won’t be 100% smooth sailing for Facebook, either. The social media firm must continue walking a fine line between maximizing user engagement and stopping the spread of misinformation. That’s no easy task in the era of partisan politics.
The company also needs to address consumer privacy and antitrust concerns. Among other warning signs: in 2019, the Federal Trade Commission levied a record-breaking $5 billion fine on Facebook. “Despite repeated promises to its billions of users worldwide that they could control how their personal information is shared, Facebook undermined consumers’ choices,” said FTC Chairman Joe Simons. “The magnitude of the $5 billion penalty … is designed not only to punish future violations but, more importantly, to change Facebook’s entire privacy culture to decrease the likelihood of continued violations.”
Finally, Facebook must continue innovating to stay on top. It acquired two of its most valuable properties (WhatsApp and Instagram) for just $5 billion together; WhatsApp now has 2 billion users, while Instagram has 1 billion. But can the company repeat its success? Perhaps, but even the mightiest of companies can always fall.
What Should Investors Do About FB Stock?
When I invest in tech companies for massive gains, I look for companies with 1) strong proprietary software, 2) a great growth trajectory, and 3) proven management. Not only does Facebook have all three. Its shares are also screaming “it’s on sale!” relative to other U.S. tech companies. And that’s what makes me excited for this social media behemoth.
Consumer shifts in the work-from-home era have given Facebook a much-needed lift. If the company can take advantage, shares could pop 40% in 2021. Perhaps it’s time to buy.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.