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Stop Thinking About Facebook as a Tech Stock, Because It’s Not

Editor’s Note: This article was updated on Aug. 11, 2021, to remove some negative language.

One of the more bothersome ideas currently obsessing the investing world is that the FANG stocks are considered technology stocks. They aren’t. Instead, they are really media and retail stocks and should be analyzed as such, beginning with Facebook (NASDAQ:FB).

someone using the Facebook (FB stock) app on their phone in front of a laptop that also has the Facebook webpage on it
Source: Chinnapong / Shutterstock.com

Along with Alphabet (NASDAQ:GOOGL), FB stock is an investment in an advertising company. Just as Netflix (NASDAQ:NFLX) holding is in a media company. You see where this is going? Amazon (NASDAQ:AMZN) is just a retail company and Apple (NASDAQ:AAPL) is a consumer products manufacturer.

The fact that these companies use innovative, disruptive and advanced technologies does not make them a tech company worthy of inflated multiples. Traditional companies. whether they be General Electric (NYSE:GE), Kraft Heinz (NASDAQ:KHC) or Berkshire Hathaway (NYSE:BRK.B), use some of the most advanced technologies available to execute their business models, yet no one’s calling them tech stocks.

So, why does an advertising company like Facebook trade at such a high multiple? Well, 27x isn’t that high, they say. But ad companies are cyclical by definition. Look at WPP (NYSE:WPP) or The Interpublic Group of Companies (NYSE:IPG).

Advertising ebbs and flows with economic cycles. The fact that we haven’t had an material economic downturn in 12 years doesn’t reduce the risk for companies like Facebook, it actually increases the risk.

Tech’s Got a New Buzzword

Facebook has joined the tech world’s embrace of thinking of its otherwise-advertising platform as a portal to the “metaverse,” that is, an immersive world where seemingly anything is possible.

“I wanted to discuss this now so that you can see the future that we’re working toward and how our major initiatives across the company are going to map to that,” CEO and founder Mark Zuckerberg told analysts following the company’s second-quarter earnings report last month.

(Readers, prepare to roll your eyes…)

“What is the metaverse?” Zuckerberg asked. “It’s a virtual environment where you can be present with people in digital spaces. You can kind of think of this as an embodied internet that you’re inside of rather than just looking at.”

That seems to have been enough to convince some analysts that everything is hunky dory and enough to justify future growth and greatness.

Morningstar is one of those. “We are increasing our fair value estimate of Facebook to $407 from $390,” wrote senior equity analyst Ali Mogharabi. Why? He goes on:

“Facebook is also investing in innovation for the long-run, including Metaverse, which we view as the next stage of growth and development in virtual reality. While Metaverse is likely to require more interoperability between many platforms and may slowly erode Facebook’s walled garden, the firm’s current network effect moat source should maintain more users on the Facebook side of the Metaverse.”

Well, he’s wrong on FB. But he’s actually a very serious analyst and good at what he does.

The Valuation Cannot Hold

Facebook will almost certainly exceed $100 billion in revenues during 2021. And other metrics are very high, with operating margins in the 38-40% range and net income margins in the 33% range. That’s not good, that’s bad. No company can sustain those margins without attracting intense competition. Unless they’re a pseudo-monopoly.

Therefore the only two choices left for Facebook’s future is decreasing margins from new innovative competition or government intervention that determines undue market power and they must be reigned in.

It’s of course absurd for this cyclical advertising company to be trading at 26x earnings and 16x EBITDA and sport a $1 trillion market cap. My calculations come up with a $260-$280 per share valuation if the company can grow at a double-digit pace for 10 years. But remember that’s almost impossible as a heavily cyclical advertising company.

Competition and the free market will eventually catch up to Facebook at some point. The Myspace trope is dated, old and may not be relevant, but from 2005 to 2008, it was the largest social networking site in the world. Someday, Facebook will be the Myspace of our young generation.

On the date of publication, Tom Kerr did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Tom Kerr has worked in the financial services industry for over 25 years. Currently he is a Senior Portfolio Manager at Rocky Peak Capital Management. Prior to that he was Chief Investment Officer and Director of Research of SGL Investment Advisors, and has served in a number of positions at other investment related organizations. Mr. Kerr has also been a contributing writer to TheStreet.comRagingBull.com and InvestorPlace.com. He’s a CFA charterholder and obtained a B.B.A in Finance from Texas Tech University.

Article printed from InvestorPlace Media, https://investorplace.com/2021/08/stop-thinking-about-facebook-as-a-tech-stock-because-its-not/.

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