Shorting Facebook Could Be Your Biggest Investment Mistake

  • Companies with high valuation often present ideal investment opportunities.
  • Why should you invest in Facebook, and how should you go about it?.
  • Does Facebook have the potential to grow, or is it a balloon waiting to pop?

As a financial writer, I often come across stocks that are highly overvalued by the market because investor expectations are strong on forward earnings. Typically, a growing company will have a forward price-to-earnings ratio of 20 or more. However, in certain extreme cases, there are no rules to valuation. Forward expectation is so high that the company must perform to those high standards; or fail. Facebook (NSDQ:FB) is one such company I’d like to discuss today.

In comparison with the rest of the FANG (Facebook, Amazon, Netflix, Google) companies - and barring Amazon (whose forward P/E stands at a hefty 56.5, giving it a market cap of $342.8 billion) - Zuckerberg’s brainchild looks like it’s trading out of bounds. At a forward P/E ratio of 28.0, that gives it a market cap of $338.9 billion.

Not a shabby place to be in! So why do investors balk at investing in FB because of its high valuation? Do they think it’s too risky a bet? That may well be the case, but the investment thesis I’m going to build around Facebook for you today will hopefully show you exactly why you need to have your money in FB if you want a piece of the future - and the best way to go about it.

Point #1: User Saturation is a Myth

FBAB1

Source: 1redDrop

As of today, Facebook has over 1.6 billion users representing well over 20% of the world’s population. User growth continues unabated through 1Q 2016.

FBAB2

What’s even more intriguing is their Daily Active User base growth, which shows no signs of flagging as of the first quarter of 2016.

FBAB3

Source: 1redDrop

The question in everybody’s mind now is this: will they reach a saturation point that matches the world’s internet user base as a whole? Complicated as that might seem, the answer is very simple. But let me put it to you as a question: will the world’s population ever “saturate”?

Let's put that in perspective:

FBAB4

It’s clear that the population of earth is on the upswing, and that’s because more babies are being born than people are dying in any given time frame.

Now, back to Facebook’s user growth, each infant that grows to the age of 13 and lives in a part of the world that is connected to the Internet is a potential Facebook user. If that’s the case, then the only other limiter to the company’s user base growth would be the penetration of internet connectivity.

FBAB5

Source: Internet Live Stats

There are currently about 3.4 billion internet users in the world today. That’s roughly 45% of the current world population. Tie that in with the fact that Facebook has only reached 50% of that penetration, and you will immediately see that this is not a metric that will saturate in the next several years.

Point #2: Unmonetized Revenue Streams

My second point is around the fact that the bulk of Facebook’s user base assets remain untapped and unmonetized.

Take Instagram, for example: apart from integrating Instagram into the Facebook ad program, they haven’t even begun to monetize the image-based social media company. When they acquired Instagram for $1 billion in 2012, Instagram wasn’t making any money. The following year Facebook introduced advertising on the platform - a move that is worth an estimated $3.2 billion in revenues for 2016 alone.

And that brings us to the next point of monetization - WhatsApp.

With over a billion registered users, WhatsApp still lies outside of Facebook’s active revenue streams. According to an article in Forbes by the Trefis Team, the latter expects average revenue per user (ARPU) on WhatsApp to hit $4 by 2020, giving Facebook a potential top line increase of $5 billion.

Facebook’s own ARPU is $3.32 as of 1Q 2016. From their earnings report:

“During the first quarter of 2016 , worldwide ARPU was $3.32, an increase of 33% from the first quarter of 2015 . Over this period, ARPU increased by 49% in United States & Canada, 33% in Europe, 32% in Asia-Pacific, and 14% in Rest of ”

This is the second reason why shorting Facebook could be the worst investment decision you make today.

Point #3: The Video Push

The third - and probably biggest - reason why you need to invest in Facebook is mobile video. Facebook is pushing hard to get into video sharing and streaming as its bread and butter of the future. In a way, that future is related to what Facebook is good at right now - monetising an ad network.

Online ads are generally reckoned in terms of cost per click, or CPC. This is the amount an advertiser pays for a click on their ad on any network. The CPC rate for Facebook text and display ads is currently in the range of $3.70. This is relatively cheap when you compare it with $15 CPCs typically found on niche websites that focus on a particular topic, and this is Facebook's major challenge with display ads.

Video, on the other hand, is a different ball game altogether. The sheer “clickability” of a video ad versus other formats is increasingly making it the go-to media type for advertisers. Here’s a snapshot of CTRs (click-through-rates) of different media types:

FBAB6

That means a user is more than 7 times more likely to click on a video ad than a static display ad. You can see why that would be a more profitable business to get into for Facebook.

And it’s not just video - it’s mobile video. The growth of video content served to smartphones is on a tremendous uptick, and this is what Facebook intends to capitalize on.

FBAB7

Source: Neomobile

By 2019, it is estimated that 72% of all mobile content consumption will come from videos. Some estimates put that at up to 80% by the year 2020. Regardless of estimates, Facebook fully intends to participate in that growth story.

They already did several tests on their video feed as of late 2015, and the company projects that in a year or two, the majority of their content will be video. Facebook Live was launched about six months ago to celebrities, and is now available to the general public. You can broadcast any event live over the Internet using the service, and one stay-at-home-mom has already made hundreds of thousands of dollars from her video going viral on Live.

The BBC recently announced that Facebook Live will be the centerpiece of their coverage of the Euro 2016 football tournament as well as the EU referendum.

The Investment Angle

Typically, with a growth stock such as FB, I would recommend a DCA (dollar cost averaging) approach to investing. Essentially, it involves putting in a fixed amount of money on a periodic basis (monthly, for example) into a stock and averaging down your cost basis over time. High valuation brings earnings shocks, and these are your entry opportunities.

For example, I’ve shown FB’s one-year stock price movement to illustrate my point:

FBAB8

The red arrows would represent where you would increase your position each time under the DCA method, thereby lowering your cost basis over a period of time.

Whether you decide to invest in FB based on the data and analysis I’ve provided is entirely your choice. My job is merely to present an opportunity that you need to investigate further before putting your hard-earned money into.

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Author's Disclosures & Disclaimers:
  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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