Facebook’s Free Cash Flow Grew in Q4, Significantly Raising Its Value

Facebook (NASDAQ:FB) released its Q4 and 2020 earnings on Jan. 27 showing that its free cash flow (FCF) surged much higher than forecast. As a result, Facebook stock is now worth 40% more, or $374.53, over its price on Feb. 5 of $268.10. And it could be worth significantly more as we get closer to 2022.

FB Stock Will Power Through Short-Term Headwinds
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Facebook produced $9.22 billion in FCF in Q4. Its full-year 2020 FCF was $23 billion, up 11.5% over last year. The Q4 FCF was also 55% more than the Q3 $5.95 billion FCF.

As a result, I raised my target price for Facebook stock. It is now $374.53, versus $352.56 in my previous article on the stock on Jan. 7. This was based on my estimate of its FCF and also an average of its forward P/E.

I believe that everyone who buys a stock should have a simple model in their head on how to value the stock. One way we can do that with Facebook is to model its FCF margin and then estimate its FCF yield. That will give us a target price.

Forecasting Facebook’s FCF

Facebook’s Q4 FCF of $9.222 billion (seen on page 9 of their announcement) represents 33% of its $28.1 billion in revenue during Q4. This important since it represents a substantial jump in that margin from prior periods.

For example, last quarter its FCF margin was just 27.7% and 22.8% last Q4. For all of 2020, its total FCF was $23 billion versus $85.97 billion in revenue. That works out to a 2020 FCF margin of just 26.8%.

Therefore, going forward, we can use this higher FCF margin to estimate its FCF for 2021 and 2022, based on sales estimates. According to Seeking Alpha, analysts expect 2021 sales to rise substantially to $107.5 billion. Sales are also forecast to rise to $128 billion in 2022.

As a result, if we apply the Q4 margin of 33% toward this means, then FCF will hit $35.5 billion in 2021. This represents a substantial gain over the $23 billion made in 2020. Moreover, it also raises the value of Facebook stock.

What Facebook Stock Is Worth

Using a 3% FCF yield implies that Facebook’s market capitalization will be worth $1.183 trillion. This is 55% above its present market cap of $763.5 billion.

How did I derive this number? First of all, at present, Facebook has a 3% FCF yield. This is because it made $23 billion in FCF in 2020 and we divide this number by its $763.5 billion market cap (i.e., 23/763.5).

Second, to forecast the 2021 market price target, we take its forecast 2021 FCF of $35.5 billion and divide that by 3%. That equals $1.183 trillion, or 55% above today.

However, we need to make one adjustment. This is based on the CFO’s outlook commentary on page 2 of Facebook’s Q4 earnings release. The most important thing he said in relation to FCF is that capital expenditures are forecast to be in the range of $21 billion to $23 billion.

This will lower FCF forecasts since its Q4 capex spending was just $4.613 billion (see page 7). This works out to $18.5 billion on a full-year run-rate basis.

Therefore, since FCF is based on operating cash flow less capex spending, we need to lower FCF by about $2.5 billion to $3.5 billion (midpoint). This is found by subtracting $18.5 billion from $21 billion and $22 billion, to allocate the capex spending.

What to Do With FB Stock

As a result, the forecast FCF for 2021 is $33 billion or $32 billion (i.e., $35.5 billion minus $2.5 – $3.5 billion). Now we can estimate its adjusted market cap. At $33 billion, the FCF margin falls to 30.7%, or 29.8% with FCF of $32 billion.

Taking $33 billion and dividing it by 3%, lowers the target market cap to $1.1 trillion. Therefore, this represents a 44% gain over its $763.5 billion market cap, down from 55% estimated earlier.

However, at the midpoint, FCF will be $32 billion (at a 29.8% FCF margin), and using a 3% FCF yield, its market cap will be $1.067 trillion. This represents a gain of 39.7% or $374.53 per share.

In other words, even after adjusting FCF in 2021 for higher capital spending, FCF rises enough to imply a 40% higher Facebook stock price.

And don’t forget analysts are already projecting significantly higher revenue in 2022. Using an adjusted 29.8% FCF margin on $128 billion in 2022 sales, as well as a 3% FCF yield, Facebook stock could be worth $1.27 trillion, or 66.5% above today’s price.

In summary, our estimate of a 40% higher price for Facebook stock at $374.53, represents a very good ROI for most investors.

On the date of publication, Mark R. Hake did not hold a long or short position (either directly or indirectly) in any of the stocks in this article.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.

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