Why the Rally in Facebook Stock Could Just Be Getting Started
Facebook stock is hitting all-time highs after the world’s largest social network posted earnings after the bell Wednesday that handily beat estimates. Facebook reported adjusted earnings of $0.97 per share vs expectations of $0.82 per share. Although Facebook stock has appreciated significantly so far in 2016, here are three reasons why the rally may just be getting started.
1) Facebook’s growth shows no signs of slowing down. Revenue increased 59%, as ad prices continued to rise due to strong advertiser demand. Overall engagement increased by a double digit percentage as well, enabling Facebook to deliver more ads.
2) Analysts are too pessimistic. Analyst Estimates are factoring in a sharp deceleration in revenue growth in 2017. Analyst expect FB’s revenue growth to slow to 35% in 2017. The main reason for this is that analysts assume growth must slow down due to the law of large numbers. However, Facebook’s ability to effectively target its massive user base on their mobile phones is likely to continue to attract ad dollars at a blistering pace. Facebook is a high growth company that is being underestimated by Wall Street. This combination of fast growth and low expectations could be setting up Facebook for a huge run, even after accounting for FB’s year to date gain of 20%.
3) Facebook is undervalued. Currently, analyst estimates for 2017 earnings are for $5.01 per share. Given the fact that FB beat the 2Q average analyst estimate by 20%, Facebook is poised to earn $6 in 2017 in our view. In fact, earnings could surpass $6 per share in 2017 if analyst estimates prove to be conservative (which has been the norm up until this point). A PE multiple of 37 times earnings against $6 per share works out to an estimated price target of $222 per share. Considering today’s price of around $125 per share, this represents upside of 77%.
Usually, dominant growth companies such as Facebook command a very high multiple. This is because not only are investors getting torrid growth, they are getting it from a dominant, blue chip company. Facebook stock currently trades at a discounted valuation due to the fact that investors are factoring in a sharp slowdown in growth. This is due to the notion that since Facebook has already become so large, that its growth must slowdown. However, Facebook still has a long runway for growth. The shift of ad dollars from other sources is still in its early innings, and advertising growth on Facebook doesn’t show any signs of slowing down. In addition to continued growth on the Facebook app, investors can look forward to Instagram to contributing more significantly to growth in coming years. Finally, as CEO Mark Zuckerberg pointed out on the earnings call, video is poised to play a bigger role on Facebook over time. This development will help Facebook both increase ad prices, as well as increase user engagement. This dynamic should lead to tremendous growth in the years ahead.
In short, Facebook continues to deliver phenomenal growth quarter after quarter and Wall Street is still skeptical. So far the skeptics have been shown to be wrong time and time again, and there is no reason to expect anything different until we are proven otherwise.
All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC
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Ideal Asset Management owns shares of FB and WFC for its clients
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