After a massive rally, Facebook stock has remained subdued despite strong earnings.
It has been a very good year for Facebook Inc (NASDAQ:FB) stock investors. The shares of eCommerce giant have delivered over 55% return this year, outperforming widely outperforming the Nasdaq Composite. Not only that, Facebook stock is also one of the best performers in the so-called 'FAANG' grouping comprising of tech giants like Apple, Amazon, Netflix and Microsoft. Only Netflix stock has performed better, that too by a slight margin.
We have been bullish on Facebook stock for a while now. Facebook stock has been part of top stocks to buy portfolio which has outperformed the Nasdaq Composite by over 175%. The strong performance delivered by Facebook Inc coupled with general bullish sentiment around big tech names have been the main driver for Facebook stock. The question now is whether Facebook stock still has any upside left? Can FB stock rally above the $200 mark by the year end?
Facebook stock is down despite strong earnings.
In its third quarter, the company delivered a blowout results, beating both the top and bottom line estimates by analysts. Facebook Inc reported non-GAAP EPS of $1.59, 77% higher than same quarter last year earnings and 29 cents more than what analysts were expecting the company to report. On the top line, FB reported $10.33B in revenue, representing a YoY growth of 47.4% and conveniently beating analysts estimates by $490 million. The company strong performance in every geographic market.
Operating profit grew by a massive 64%, from $3.11 billion to $5.12 billion driving operating margin to 50% from 44% in the comparable quarter last year. The company generated over $4.3 billion in free cash flow. The company also lowered its guidance for this years opex growth from 40%-45% range to 35%-40% range. However, despite this strong performance Facebook stock is down over 2% since earnings while Nasdaq Composite is marginally up in the same period. So, what is keeping a check on FB stock price?
One of the key factors which is acting as a headwind for Facebook stock is regulatory challenges. Facebook is embroiled in several controversies including the Russia controversy, cyberbullying, breach of privacy and tax evasion. As we had expected Russia controversy dominated the company's third-quarter earnings with Facebook CEO Mark Zuckerberg vowing to bring "even higher standard of transparency than ads on TV or other media". Facebook officials also testified before the Congress. However, many still believe that the company is not doing enough to fight the issue. The clamor for regulating entities like Facebook is gaining momentum. Facebook is also facing criticism for the way it handles users confidential data.
Facebook is also facing charges of tax evasion, mainly in Europe. In a report published in the end of October, the European Commision said that multinational corporation like Facebook, tend to pay much lower taxes at typically 10.1% tax rate in the EU, compared with a 23.2% rate levied on traditional companies. To close this gap, EU led by France is proposing a tax on turnover in the place where the actual sales occurred, a change from the current set up where the profits are taxed in the countries where the company is located. While this proposal could take time to come to life, it could create a significant tax burden for Facebook. Lower taxes was one of the main reason behind strong earnings growth in the current quarter. In the third quarter, Facebook had an effective tax rate of 10%, lower than 16% in the same quarter last year and 35% U.S corporate tax rate.
Rising expenses could drag profit margins.
While the above-mentioned controversies have been around for a while, the announcement by the Facebook management during the earnings call that the company could see strong growth in expenses has been the main headwind for the Facebook stock. During the earnings call, CFO David Wehner warned that Facebook's operating expenses may rise between 45% to 60%, a huge jump from this year’s expected rate of 35% to 40%. A large part of the increase expenses is driven by the Russia controversy. The company is set to double the headcount of staff working on safety and security to 20,000. "I've directed our teams to invest so much in security on top of the other investments we're making that it will significantly impact our profitability going forward, ... Protecting our community is more important than maximizing our profits." Facebook CEO Mark Zuckerberg said during the earnings call.
Management also warned that capital spending will double from this year's level. The company will invest significantly in its video platform "Watch". There were reports that Facebook is willing to spend up to $1 billion in producing and promoting video content. Facebook expects video to be a strong growth driver in the medium term.
Facebook stock is losing momentum.
The strong warning from Facebook management and the ongoing Russia controversy will keep a check on Facebook stock for the remainder of this year. In fact, Facebook stock has remained largely subdued, except for a strong up move, since the end of July. While Facebook stock still remains a strong long-term buy, it is unlikely to make any strong move going into the holiday season.
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