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Facebook: Great Business, Bad Stock

Facebook: Great Business, Bad Stock
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By Thursday, 17 September 2020 06:03 PM Current | Bio | Archive

Facebook (FB) is a widely-followed stock. As a major tech stock, it is owned heavily by institutional investors such as Boston-based asset manager Altimeter Capital. Facebook stock has registered impressive returns since its IPO in 2012.

But after such an impressive rally, it is reasonable to question whether the stock is still a buy right now, especially given the challenges facing the global economy due to the coronavirus pandemic.

While we view Facebook as a very high-quality business, the stock appears significantly overvalued, which we expect to meaningfully reduce shareholder returns over the next five years. As a result, we see Facebook stock as a hold, but not a buy right now.

Business Overview and Recent Earnings

Founded in 2004 by Mark Zuckerberg and fellow students at Harvard University, today Facebook operates as the world’s leading social network through its namesake website. At the end of Q2 2020 the site had 1.79 billion active daily users and 2.70 billion active monthly users. The company’s “family” of offerings also includes Instagram, WhatsApp and Messenger, with Facebook estimating that 3.14 billion people use at least one of their services. The company has a market cap of ~$726 billion.

On July 30th, 2020 Facebook released Q2 2020 results for the period ending June 30th, 2020. For the quarter total revenue came in at $18.69 billion, a 10.7% increase compared to the $16.89 billion posted in Q2 20219. Net income totaled $5.18 billion ($1.80 per share), compared to $2.62 billion ($0.91 per share) in the prior year quarter. However, Q22019 results were skewed by special legal and tax items.

Facebook also provided an update related to the COVID-19 pandemic and business expectations. The company anticipates flat or slightly down daily and monthly active users as restrictions around the world ease. Revenue was growing at approximately 10% in the first three weeks of July, and this trend is expected to continue for the quarter. Total expenses are expected to be $52 billion to $55 billion, with $16 billion in capital expenditures.

Growth Does Not Justify the Current Valuation

Even though the company has performed well fundamentally to start 2020, we believe shares are overvalued right now. Based on our EPS estimate of $9.00, shares trade for a price-to-earnings ratio of 28.3. We have assigned a fair value P/E of 22 as a reasonable baseline, taking into consideration two items. First, the continued above average growth rate deserves a premium valuation. Second, the company’s cash and security hoard –sitting at ~$20 per share against total liabilities of ~$10 per share –deserves premium consideration as well.

This position provides excellent flexibility for Facebook to either acquire firms down the line or start repurchasing meaningful amounts of stock; both of which can aid future growth. Still, as shares are currently trading above 28 times estimated earnings power, we see a significant headwind to the valuation moving forward.

This could have a meaningful impact on shareholder returns. For example, if Facebook’s valuation declined to the fair value estimate of 22 over the next five years, it would reduce annual returns by approximately 5% per year. As a result, even if the company generates 9% annual EPS growth for example, total returns would amount to just 4% per year due to the impact of a declining valuation multiple.

Final Thoughts

Facebook has been one of the market’s premier growth stocks over the past decade. It has earned its place in the group of FAANG stocks which encompass the market’s top large-cap growth stocks. However, we believe the current valuation has exceeded fair value, even with the company’s continued growth to start 2020. As a result, we believe investors should avoid Facebook until a meaningful decline in the share price makes it a more attractive stock.

Bob Ciura has worked at Sure Dividend since October 2016. He oversees all content for Sure Dividend and its partner sites. Bob received a Bachelor’s degree in Finance from DePaul University, and an MBA with a concentration in Investments from the University of Notre Dame.

 

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Facebook (FB) is a widely-followed stock. As a major tech stock, it is owned heavily by institutional investors such as Boston-based asset manager Altimeter Capital. Facebook stock has registered impressive returns since its IPO in 2012.
facebook, great, business, bad, stock
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2020-03-17
Thursday, 17 September 2020 06:03 PM
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