Facebook stock enters 2017 on a combination of lower expectations and depressed valuations.
Shares of Facebook (NASDAQ:FB) are off to a great start in the new year. FB stock is up 8%+ since the turn of the year. In comparison, the stock had gained 9.55% in 2016, outperforming the Nasdaq Composite's (INDX:COMPX) 6.6% gains. As reported in our last FB post, Facebook stock has had strong momentum behind it, having broken through key resistance levels as it rallied through the first week of 2017. However, there are reasons to believe that the first week was only an indication of what's to come, as FB stock looks set for a very strong 2017.
Facebook Enters 2017 With Lower Expectations
Facebook CFO David Wehner sort of brought investor expectations down to the ground when he provided a cautious outlook for Facebook's growth in Q4 2016 and 2017. The market seems to have hung on to his comments that 'ad load growth' will slow down, which could hurt Facebook's growth. This has also resulted in a clear drag on FB stock. Facebook stock price dropped from $127.17 on November 2, 2016 (date of Facebook's last earnings call), to close the year at $115.05, down nearly 10% in the last 2 months of the year. The latest rally is yet to bring the stock back to its pre-Q3 2016 price of $127, as the stock closed the last trading session at $124.35 (Jan 10). It is reasonable to conclude that fears of 'slowing ad load' have clearly left FB investors worried, with the announcement dealing a blow to Facebook's growth prospects, in the eyes of the investors. (See also: This Could Hurt Facebook Inc (FB) Stock In The Long Run)
Facebook Earnings Are Exploding, Valuations Are Falling
In the midst of bearish concerns, Facebook investors seem to have missed the bigger picture. Facebook's earnings have more than doubled in 2016. Facebook reported net income of $5.93B through the first 3 quarters of 2016, good for 179% YoY growth over the first 3 quarters of 2015. Facebook's Q4 net income will likely exceed $2.5B, which should bring the total FY 2016 net income to $8.43B, good for a 130% YoY growth. The strong earnings growth has come on the back of expanding margins with net income margins rising from 26.7% in Q4 2015 to 33.9% in the latest quarter. This explosive earnings growth combined with recent growth concerns has seen the company's valuations come down to more reasonable levels.
Facebook stock currently trades at a PE of 48, down from a 100+ PE just a year ago. Wall Street analysts currently expect the firm to grow earnings at 36% CAGR over the next 5 years, making the FB stock an attractive buy at current price levels. Given the huge divergence between the FB stock price movement and the company's fundamentals in 2016, Facebook stock looks set for strong earnings growth driven rally in 2017. (See also: Shorting Facebook Inc. (FB) Stock Now Could Be A Disastrous Move)
Facebook Still Has Multiple growth drivers
Facebook still has multiple growth drivers which can be leveraged to maintain its strong growth trajectory, in spite of the potential slowdown in ad load growth on the core platform. As per a recent Recode report, Facebook is testing out mid-roll ads, which should further help the company's video ad revenue. Apart from the video ad efforts, increasing ad revenue from Instagram should also help offset the 'ad load slowdown' on the core platform. While Instagram and video ads are the next key drivers of Facebook's growth, the company still has many potential growth drivers in the likes of Whatsapp and FB Messenger. Facebook's multiple potential growth drivers have been cited in various recent analyst notes.
Doug Anmuth from JPMorgan recently picked FB as a 'top large cap idea for 2017'. As per a CNBC report, the analyst wrote, "In our view a number of concerns have contributed to the recent wall of worry including potential for meaningful revenue deceleration [and] slowing ad load growth," analyst Doug Anmuth wrote in a note to clients Tuesday. "However, we believe these fears are largely overdone and continue to create a good buying opportunity. ... [We reiterate] FB as our top large-cap pick." Cowen and company upped their FB target price to $156 observing "video ad market strength and other positive indicators gleaned through a conducted ad survey." These bullish notes came on the back of positive commentary from Oppenheimer analyst Jason Helfstein, who recently picked Facebook stock as a top pick for 2017, citing increased ad spending in Q4 2016 and the rapid growth of Instagram.
Putting it all together
Facebook enters 2017 with a combination of lower expectations and depressed valuations. The strong earnings growth in 2016 has failed to have a similar impact on the FB stock price, as investors were spooked by growth concerns. However, Facebook's multiple growth drivers, like Instagram and rising video ad revenue, should more than offset the slower growth on the core Facebook platform. With the FB growth story still intact, the depressed valuations position Facebook for a strong 2017. Any earnings surprises over the coming quarters should lead to a strong rally in FB stock price.
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