What Are The Risks Of Investing In Facebook Stock Right Now?

  • Nearly all of Facebook's revenue growth is from mobile, coming from the US and Europe, with poor momentum for Asia-Pacific.
  • With 2.5 million advertisers currently, Facebook needs engagement levels to increase even more for ads not to be saturated too much.
  • Virtual Reality is looked upon as being the next big growth driver for Facebook. However risks persist due to elevated investment and stiff competition.

Facebook (NASDAQ:FB) is now trading north of $112 a share as its fourth quarter earnings beat analysts expectations across multiple metrics. For a company this large ($319 billion market cap) to beat earnings estimates by 18% was impressive, considering that only about half the world's population have access to the Internet. Nevertheless, Facebook's monthly active users came in at almost 1.6 billion which was a 14% hike from Q4-2014. But that wasn't the real story of Facebook's success in the quarter, mobile was.

Facebook has been the most successful company in the technology sector to date with respect to the ongoing shift to mobile which is taking place at the moment. I find this ironic considering that this company had no mobile plan or presence less than 4 years ago when it held its IPO. Advertising revenue came in at $5.6 billion, and due to the increasing number of mobile users being engaged over the fourth quarter, mobile revenues made up 80% of all advertising revenues.



The surge in Facebook's stock has meant that valuation metrics are now at pricey multiples. Facebook's price to sales ratio is now at over 17, and its price to earnings ratio is just over 87, although its earnings multiple has traded at higher multiples in the past. Analysts are looking for an EPS of $3.14 and revenues of $25.41 billion in 2016, which means revenue growth is predicted to slow in the next few years. However, Facebook stock is priced to perfection and needs every bit of the momentum it has gathered thus far to justify its valuation.

The first area where it needs to keep its foot to the floor is not so much growing users, but actually growing the average revenue per user meaningfully. Although monthly active users are still growing at a healthy clip, this has to taper off at some point, which is why engagement levels are key.

Facebook's ARPU metric ( average revenue per user) came in at $3.73 in the last quarter which was up substantially from $2.81 in Q4-2014. However, majority of this growth is still coming from Europe and the U.S. which is worrying for long term investors. The Asia Pacific region saw the smallest growth last quarter, as average revenue per user only came in at $1.59, and this is a metric that needs to increase at a faster clip if Facebook is going to continue to grow strongly. Why? Well whatever Facebook is doing regarding the deliverance of its mobile ads, you can be sure that other platforms will go down the same route. Furthermore, the west is where most U.S. multinationals like Alphabet Inc-C (NASDAQ:GOOG) and Twitter (NYSE:TWTR) are strong, and I see fierce competition in this sector for traffic in the coming years. Facebook cant continue to increase its ARPU metric meaningfully in the west since it's a saturated market. More ads hasn't deterred users as yet, but they eventually will, if Facebook continues to try and extract more income from the same base of western users.

The other major growth triggers are WhatsApp, Instagram and Oculus virtual reality. CEO Mark Zuckerberg mentioned on the earnings call that WhatsApp monetization will involve users being able to communicate and interact with certain businesses. Income potential is definitely high here considering the 1 billion user base the service currently has. Instagram also has huge potential in the fact that engagement levels should be higher on this platform. For example Facebook wasn't slow in announcing that a company by the name of Shutterfly (NASDAQ:SFLY) made more than 6 times its initial advertising investment over the holidays on Instagram. The targeting Facebook can do inside Instagram makes these returns on investments on marketing campaigns possible, but the management has still not published the platform's performance thus far.

Oculus virtual reality though will probably be one of the biggest areas of investment for Facebook going forward. This initiative has the potential to really increase revenues due to a paradigm shift that is taking place in computing. Facebook is at the forefront of that technology shift but that doesn't necessarily mean that this initiative will be successful. Why? Again heightened competition. Apple (NASDAQ:AAPL) recently declared its intent in this area by developing potential VR headset prototypes, acquiring a company called Flyby Media plus setting up an extensive research team that will work exclusively on Virtual Reality. Apple may have come late to the party in this space, but its balance sheet (through elevated investment) could bring the company up to speed in no time.

To sum up, Facebook delivered an outstanding set of results in its fourth quarter, which has majority analysts bullish on its prospects for 2016. The trend is definitely with the social media behemoth, but I see increasing competition in the next few years. Facebook now has 2.5 million advertisers on its books, which mean the volume of ads increased substantially across its main platforms. Elevated engagement levels are key going forward for Facebook as this is the only way the company can deliver huge volumes of ads without alienating some users. Stiffer competition would be detrimental here.

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  • 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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