Facebook — now known as Meta Platforms (NASDAQ:FB) — looks like good value now. That’s true despite all the controversy it has gone through in the past several months. After dipping to just over $306 on Dec. 3, recently FB stock has started to rebound.
On Dec. 7 it traded at $322.81 and could be poised to move significantly higher. In fact, since Oct. 28, when Mark Zuckerberg rebranded the company into Meta Platforms, it is actually up about 2% from $316.92.
I, alongside several other analysts, believe that Meta is likely to move significantly higher over the next year.
For example, Barron’s recently reported that at least one analyst is starting to like the stock. HSBC analyst Nicolas Cote-Colisson raised his rating on shares to Hold. Prior to this, his recommendation was to Reduce. However, he still has a price target of $300.
His slightly more positive stance on FB stock is due to his belief that the company could benefit from acquisitions it can make in the metaverse. But that is not the best reason to buy Facebook. The company is likely to continue to benefit from a large shift in corporate spending to digital ads.
Where Things Are Headed With Facebook
The truth is that most of the company’s revenue and earnings come from its huge ad revenue. On Oct. 25, Facebook reported that its Q3 advertising revenue rose 33% over the same period last year. Its total revenue was 35% higher year-over-year (YOY).
In effect, digital ad revenue represents 97.5% of its total revenue. So, despite all the talk about the company being a “metaverse” conglomerate, the truth is that ad revenue still powers and runs this ship.
In addition, Facebook reported a massive net income of over $9.19 billion, up over 17% YoY. This represents a huge 31.7% net income margin on its $29.01 billion in revenue. So, ad income is extremely important for Facebook. It is not going to move away from this stream of income anytime soon.
But more importantly, Facebook produces huge amounts of free cash flow (FCF). For example, page 20 of its earnings slide deck shows that FCF has grown to $9.547 billion as of Q3 2021. That is greater than its net income and represents an FCF margin of 32.9%, higher than the 31.7% net income margin.
Moreover, page 20 of the deck shows the progression of its FCF over time. You can clearly see that 2 years ago in Q3 2019, Facebook generated $5.631 billion in FCF. So over the past 2 years, FCF has risen 69.5%.
In addition, in Q3 2019, Facebook’s quarterly revenue was $17.75 billion, so its FCF margin was only 31.9%. That compares with 32.9% in Q3 2021, as I mentioned above. In other words, with higher revenue (up 63.4% over 2 years), its FCF margins have expanded. That proves that Facebook not only has huge operating leverage but is basically a cash cow machine.
And it all depends on its powerful digital ad revenue. Companies find more and more that it pays to advertise their products on Facebook’s platforms. This is not going to change anytime soon.
What FB Stock Is Worth
The simplest way to value FB stock is to use a FCF yield metric. In the past, I have argued that using a 3% FCF yield is the best way to value Facebook.
To do this, I like to use analysts’ estimates for revenue at least one full year in the future. For example, Seeking Alpha’s survey of 49 analysts shows that their average 2022 revenue forecast is $140.19 billion. That represents a 19% rise over 2021 estimates.
Therefore, if we apply Facebook’s 32.9% FCF margin to this revenue forecast, we derive a potential FCF of $46.1 billion (i.e., 0.329 x $140.19 billion rev). Next, we apply a 3% FCF yield to this estimate.
To do this, divide $46.1 billion by 0.03. The result is a target market cap of $1.537 billion. That is 73.8% over today’s market cap of $884.2 billion. That implies FB stock is worth $574.72 (i.e., 73.8% over the price as of Dec. 7).
But just to be even more conservative, let’s reduce its value metric. For example, let’s say that analysts’ estimates are too generous. With just 17% revenue growth and a 30% margin, FCF next year works out to $41.3 billion (i.e., 1.17 x $117.64 billion x 0.30). Now, using a 3.0% FCF yield the market cap target is just $1.376 billion. That is still 55.7% over today’s market cap and works out to a price of $514.87 per share.
Even at this lower valuation FB stock is way too cheap. By the end of next year, it could be 56% higher at $515 per share at a $1.376 billion market cap.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.