Facebook Stock Is Poised To Outperform

  • Facebook is the premier momentum stock in this market and looks to be on the verge of a powerful advance.
  • Underperforming fund managers will pile into FB and other momentum stocks.
  • It is the primary beneficiary of the growth in mobile advertising, and is poised for further growth.
  • Facebook stock is currently at a low risk entry point.

Facebook technical analysis

Facebook stock (NASDAQ:FB) is one of the strongest stocks in the market from absolute and relative price performance as well as its revenue growth, earnings growth, and margins.  Expectations around the company are very optimistic with a Price to Sales ratio of 19.  It is the typical momentum stock and as long as the company exceeds expectations and the overall stock market remains in a “risk on” mode, the stock should continue to outperform.

The two risks to Facebook are a decline in user engagement or effectiveness of ads causing advertisers to flee and a change in the market’s perception towards risky assets leading to multiple contraction, which would hit momentum stocks the hardest.  Recent growth in the mobile advertising market has led to a boom in the bottom line.  Additionally, the stock market’s recent move to record highs has dispelled this threat of multiple contraction in the near term, at least as the market returns to a “risk on” environment.

Instead, the stock market’s move to record highs with institutional fund managers under exposed is a powerful catalyst for Facebook’s stock price in the short term.  Facebook is one of the most desired destinations for underperforming institutional managers due to its string of impressive earnings reports, huge float, and accumulation pattern.

Fund Managers Underexposed

After an impressive earnings report in July, Facebook gapped up to new highs hitting 76.74.  The earnings report was particularly appetizing to investors as it showed an acceleration in revenue growth, earnings, and margins.  These are the major metrics that institutional investors use to judge momentum stocks, and FB passed with flying colors.  Another positive for the stock is its strong accumulation in a weak market.

Due to the inherent riskiness of momentum stocks, when the overall market corrects, they tend to fall more than the overall market.  In the recent selloff, while the major indexes like the S&P 500 and Dow Jones Industrial Average were making lower lows, Facebook was making higher highs.  This was one sign that investors were using the stock market weakness as an opportunity to accumulate shares.  Below is a comparison of Facebook and the S&P 500 over the last six months:

Facebook stock price v/s S&P 500 movement

Facebook_S&P movement

Notice the stability of Facebook’s stock in the late July, early August period versus the violent selloff in the S&P 500.  Looking forward, the S&P 500 has bounced from these levels all the way to straight highs.  During the selloff, there was a ton of fear about downside risks, with sentiment measures and oversold indicators at extreme levels due to worries about geopolitical risk, as conflicts escalated in Syria, Iraq, Israel, and between Ukraine and Russia.  Additionally, there were fears of dislocation in the junk bond market potentially creating dislocations in the stock market.

It is important to review this recent history because with these concerns swirling, money managers aggressively reduced exposure to the market.  At the same time, a strong bid remained for Facebook, while it evaporated for many stocks.  Warren Buffett likes to talk about when the tide recedes, we find out who is swimming naked.  Well for a few days the tide of liquidity receded, and Facebook continued to hold up.  As for now, the stock is not swimming naked.  Certainly, institutional managers took notice.

Going back to the fund managers, with the stock market heating up back to new highs, many remain on the sidelines.  At the bottom in early August, managers were 50% exposed to the market, and now with the market hitting new highs, they are only 57% of the market.  These fund managers are judged by their ability to beat the S&P 500 and can find themselves out of a job, if they fail to beat this benchmark.

If the market continues to move up or stay at these levels, then they will be compelled to pile into high beta stocks to make up for their underperformance.  Facebook with its massive float in the billions, impressive growth, and accumulation pattern, is the perfect vehicle for these underperforming fund managers looking to close the gap.  Below is the National Association of Active Investment Managers (NAAIM) Exposure Index.

National Association of Active Investment Managers Exposure index

Exposure index

There were similar instances of the market hitting all time highs and fund managers being underexposed in November 2013 and May 2014.  Each instance led to a trending move higher in the indexes and momentum stocks rallied impressively over the following months.  Facebook experienced weakness with the overall market but these trending moves led to almost 60% gains from November 2013 to March 2014.  In May, Facebook bottomed around 55 and currently it is at 75,a 36% gain.

Facebook mobile Ad revenue growth

The driving force behind Facebook’s rapid appreciation in share price and future potential has been the secular growth in the mobile advertising space and its effectiveness with mobile ads.  This was clearly reflected in its latest earnings report as the company announced YoY revenue growth of 61% as well as an increase in income of 147%.  Additionally, margins expanded from 31% to 48%.

A study of the biggest stock market winners of the past century concluded that the commonality between all the big winners were gains in sales, earnings, and margins over many years. This was the key ingredient to being a superstock.  Certainly, Facebook fits this criteria at the moment. There is little reason to believe this is going to change in the near future, given the continued explosion in the mobile ad space.  The total spending on advertising globally is $520 billion.  Currently, mobile is a tiny slice of that pie but it is expected to grow 61% in 2014.  Further, it is expected to grow by 50% for the next 3 years. Despite more people now consuming content on mobile devices than desktops, mobile only gets 20% of ad spending.  However, this is impressive growth from 2012 when it was 8% of all digital advertising.

Overall, mobile remains a tiny portion of total ad spending, however it will continue to rapidly grow as the chart below shows.

Global ad spend trends

global ad spend growth

Facebook is poised to capture much of these gains, as it has come up with ways for advertisers to effectively spend on ads in users’ newsfeeds.  62% of Facebook’s revenues comes from mobile ad spending, and it receives about 18% of the mobile ad spending this year, doubling its market share in a growing market.  The table below contains 2014-2016 projections for US mobile ad spending, Facebook’s market share of the mobile ad market, and revenues.

Year US Mobile Ad Market FB Market Share FB Mobile Revenue
2014 $17.7 billion 18% $3.2 billion
2015 $29 billion 23% $6.7 billion
2016 $44 billion 27% $11.9 billion

Conclusion

One concern for these managers is it takes effort to build positions, as their buying power can move the stock itself, so they use periods of market weakness to soak up supply.  However with Facebook, this is less of an issue due to its liquidity and massive float of almost 2 billion shares.  This huge supply of shares is currently an asset in this market environment.  It provides fund managers a vehicle to play catch up with the rest of the market, without worrying that its own buying will drive up the price.  Of course in a bear market, this becomes a liability when demand dries up and risk appetites shrink.

Facebook is very close to its all time high and a break from this level should lead to a rapid move higher, as traders chase the breakout.  However, in the stock market as in life, there are no certainties, so it is also good to consider risk.  In this situation, risk levels are quite appropriate as the post earnings low of 71.55 should not be violated if fund managers are accumulating and chasing the market.  This is a risk of 4%.  Another even more low risk approach is to only buy on a break above the highs on strong volume.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article himself, and it expresses his personal opinions. The author is not receiving compensation for it (other than from Amigobulls). The author has no business relationship with any company whose stock is mentioned in this article.

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