- Mobile advertising accounted for 78% of the total revenue take.
- FB also re-accelerated its user growth numbers which resulted in the stock rallying hard in after hours trading.
- Company should continue to grow due to new advertisers and users alike using the platform.
- To achieve net income growth on top of current heavy investing is very impressive.
- Valuation is still out of whack. Recessionary and regulatory fears could also hurt this stock going forward.
Mobile advertising was the buzz word for Facebook (NASDAQ:FB) third quarter earnings, as the metric was the principal reason why the social media giant easily beat estimates of revenue and EPS. Earnings reported were $0.57 on revenues of $4.5 billion compared to average EPS estimates of $0.52 and $4.37 billion in revenue. In after hours trading on the 4th of November, the stock rallied almost up to $108 a share and if the share price opens up around these levels today, its year to date performance so far wouldn't be far shy of 40% which is outstanding for a large cap company. Can Facebook keep this growth going? I think it is fair to say it can, especially when you see that the company can still make fat profits despite the big capital investment programs it is currently undergoing. Let's go through this article and discuss where the company is definitely making headway, and why I am still cautious about investing in this stock going forward.
Facebook Earnings Highlights
Firstly, and as mentioned above, mobile sales drove the revenue growth this quarter, as this segment accounted for 78% of the $4.5 billion in revenue, which was well up from Q2 this year (66%) and also Q3 2014 (76%). There are a number of positive themes that came out of earnings that investors should be aware of. Firstly, Facebook is definitely riding the trend of the growing video and mobile advertising markets. Video views across its services have reached 8 billion and will undoubtedly continue to grow as the company will gradually take market share off its competitors and also attract attention from more TV advertisers.
In fact, Facebook also seems to have the best performing mobile units in the sector as growth there also has been very impressive especially when you consider that the company only entered this market 3 years ago. However, the most impressive metric was its user growth which was the main reason in my opinion the stock soared in after hours. The company has managed to "re-accelerate" its user growth both across its daily and monthly users metric. Furthermore engagement levels are staying at around 65% (Daily users/monthly users) which is impressive. Daily users have risen to 1.01 billion which is a 17% increase compared to the quarter of 12 months prior. Everything seem to be on the up in Facebook. For example, Instagram which now has more users than Twitter, and has recently started to show ads is bound to grow from present levels although management wouldn't go into detail on how growth would be scaled. Furthermore other products where user numbers are growing such as Messenger and WhatsApp (900 million users) have not even been monetized yet which demonstrates more growth potential. Big numbers were definitely touted after Q3 which will definitely attract momentum investors and advertisers alike. However astute investors will always look at the other side (contrarians) to see what could lie ahead if things were to go awry.
The Risks Ahead
The main metric that will grow Facebook's business meaningfully is its advertisers base which is currently at 2.5 million. Facebook is still investing in improving its ad relevancy to ensure "advertisers" stick around and keep spending advertising dollars. What potential risks do I see here? Well if usage or engagement slowed, advertisers would undoubtedly see a poorer return on their investment dollars. The question that has to be asked is "How much more can ad performance be improved to limit showing more ads"? Up to now engagement levels of its users have been adequate enough to support more advertisers on its platform. But what would happen if revenue was still increasing with stagnant user growth? Another question that analysts are not posing is where is the growth of the users taking place compared to advertisers. A lot of the company's user growth is taking place in the east and it has already been confirmed that the dollar value per user in this part of the world is much lower than the west. Should a local advertiser (country specific) for example be marketing on Facebook if the local area in question had sluggish user growth compared to advertiser growth?
Also this company has never really suffered a recession and I think investors should keep this in mind especially when you take into the account the very weak recovery (still 0% interest rates) the US has had since 2010. Why is this important? Well global advertising in 2009 suffered its sharpest decline since the great depression of the 1930's. There is a high correlation (81%) between a country's GDP (The US is where Facebook derives most of its income by far) and advertising budgets. The clear risk here is that if budgets fell in the US, I could envisage seeing Facebook accelerating its ads output. This would be very risky on their part but being a company that has so much future earnings priced into its stock, it needs to continue the growth path otherwise investors would become disinterested very quickly.
Finally on the subject of its valuation and after its post earnings rally (which may not be done yet and the stock will probably surpass the $300 billion market cap metric soon), the company has a present p/e ratio of 109 which is crazy. Would you invest in a company trading for more than 100 times earnings? Obviously many do, and its the excitement and the growth numbers that attract them in hoards. To give you an insight of how overvalued this stock is (compared to another), take a look at numbers over at IBM (NYSE:IBM) which pays a fat dividend and a current p/e ratio of under 10. Last year this tech stock had revenues of $92 billion (Facebook had just over $12 billion) which gave a net income of over $15 billion (Facebook had just less than $3 billion) yet the market has it valued at less than 50% of Facebook's valuation ($137 billion)??. Why? Underlying trends and growth forecasts. Facebook should undoubtedly grow from here, but enough to justify its valuation? I'm not so sure.
Facebook Earnings Summary - Q3 2015
To sum up, Facebook came out again with very impressive numbers and growth rates. Furthermore it is doing this while investing heavily in programs such as artificial intelligence and virtual reality. However future growth has been priced too much into this stock in my opinion. Yes there should be upside left but the risk here in my opinion outweighs the potential reward.