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Equity Focus: Facebook (FB)


As with our equity feature on Merck two weeks ago, this article should not be considered as investment advice. Rather, it briefly summaries why Facebook could be considered a good investment, as well as some of its shortcomings. If you're interested in investing in Facebook, please make sure to do your own research prior to making any decisions.


Now, on to the fun stuff...



Facebook needs no introduction. About one in three people in the world regularly use the platform, making it the largest global social media platform, with over 2.5bn monthly active users. It owns similar social media platforms such as WhatsApp and Instagram, as well as other top tech companies, including Oculus. Since its IPO back in May 2012 (if you don't know what an IPO is, check out our article on them here), Facebook's share price has risen 498%. Below, I detail some of the most compelling arguments both for and against investing in Facebook.



Case for Investment

1. Facebook is the most used social media site globally. It has the largest market share, which is boosted by its ownership of WhatsApp and Instagram.


2. FAANG (Facebook, Apple, Amazon, Netflix, and Google) stocks have outperformed the wider market during the coronavirus pandemic, and there are no signs that this trend is slowing down. During the last months in which many of the world’s companies have been terribly impacted by Covid-19, Facebook’s engagement levels have skyrocketed. Furthermore, its Q1 2020 ‘other’ revenue. (i.e. non-advertising) increased by 80%.


3. Facebook recently announced the launch of a new platform – Facebook Shops. This will enable businesses to set up stores on Facebook and Instagram rent-free, partnering with the increasingly successful Shopify, as well as other e-commerce platforms. Facebook Shops is an unknown quantity in terms of its long-term revenue value, but analysts estimate that it will bring in between $4bn and $30bn per annum, through a combination of advertising revenue and a fractional share of transactions. With the expansion of this likely to come through WhatsApp and Instagram as well, Facebook Shops will ensure the company’s success throughout a period where many physical shops and businesses around the world are closed, as well as further into the future.


4. Facebook is a “cash cow” – annual free cash flow has risen from $6bn in 2015 to over $20bn in 2019. Likewise, net income has increased six-fold in the same period. EPS (earnings per share) are forecast to jump 33.5% in 2021, and predicted to grow at an average rate of 14.3% over the next five years.



5. The rise in popularity of ‘stories’ as a feature on Facebook, Instagram, and WhatsApp will allow for further advertising revenue gains.


6. Facebook has an extremely robust balance sheet. With very low long-term debt commitments, over $60bn in cash, and current and cash ratios of 4.6x and 4.0x respectively, it has proved that even in the toughest climates, it can survive quite easily.


7. Facebook is heavily focused on ensuring its future at the top of the tech industry. For this reason, its research and development investment in Q1 2020 alone, which was up 40% from the same time last year, shows its desire to maintain its competitive advantage. Ownership of companies such as Oculus, the leading Virtual Reality firm, again evidences its plans for the future.

Drawbacks/Risks

1. Regulation – Facebook has been under scrutiny and been heavily criticised in the past for illegal data sharing and security breaches. Likely tighter government regulation on the company may increase Facebook’s costs, but then again, it will ensure that its reputation remains strong and prevent any further damages.





2. Mark Zuckerberg’s recent 'situation' with Donald Trump and refusal to censor any of his posts has sparked uproar within the technology community. The backlash has led to a plethora of internal resignations, with employees unhappy with Zuckerberg’s allegiance to the President. This talent drain could be costly, or it could be a short-term blip, with the latter more likely in my opinion.


3. Facebook is still in its first generation of users. Figures show that daily, monthly, and yearly active users are increasing, but will this trend continue in the future? Investors only have to look at the grim fates of social media companies such as MySpace, or dot com firms, to know that tremendous growth over a five-year period doesn’t guarantee lasting success.


4. Valuation – Many believe that Facebook is overvalued. With a current P/E of 32, a forward P/E of 31.6, and a P/B of more than 6, it could be argued that now is not the right time to buy Facebook stock. Similarly, although Goldman Sachs issued a new, upgraded price target yesterday (driven by optimism over Facebook Shops), the new $250 price target offers limited (but still positive) upside from the current share price of $229.

Q1 2020 Results Highlights (year-on-year)

- Total Revenue up 18% (advertising revenue up 17% and other revenue up 80%)

- Total Costs up 1%

- Operating Income up 78%

- Operating Margin at 33% (2019 Q1: 22%)

- Net Income up 102%

- Diluted EPS up 101%

- Daily Active Users in March up 11%

- Cash and Equivalents of $60.29bn as at 31.3.2020

- Free Cash Flow of $7.34bn

2019 Full-Year Financial Highlights


Final Thoughts


Facebook is not cheap. Last week, its share price was at its all-time high. Low-upside price targets, regulatory news, and Covid-19’s negative impact on advertising revenue, all hamper Facebook’s prospects. However, it’s P/E and P/B are lower than previous highs. Its PEG ratio of about 1.8 means that it is trading at a premium, but this is still cheaper than its rivals. Its historic levels of growth are unbelievable (e.g. revenue has increased by more than 50% in 2 years), and it is certain to grow at a similar rate in the future. Cash is king for Facebook, and its strong balance sheet is second-to-none. It is even more impressive that its current assets are continuing to grow healthily each year, while current liabilities have remained relatively flat.

The bottom line is that Facebook, while dear, is a great stock. Its fundamentals are fantastic, growth will be increasingly driven by Facebook Shops, and ultimately, there are few companies like it. However, there are drawbacks and risks, and it is vital to conduct your own analysis before deciding whether to invest in Facebook.



Disclaimer:


The Student Investor is not a registered investment, legal or tax advisor or broker/dealer. All opinions expressed by The Student Investor are from the personal research of the author, and are written for educational purposes only. Although best efforts are made to ensure that all information is accurate and up-to-date, occasionally unintended errors and misprints may occur. Please note that the value of your investment can go up or down, and The Student Investor takes no responsibility for any decisions made by readers.