- Any downside risks in Facebook stock are going to be protected by engagement levels on Facebook's platform.
- Facebook probably knows more about its users than any other company online. This is a huge advantage for Facebook and its advertisers.
- The growth of video across Facebook's platforms will attract more advertisers, which have grown to 4 million.
Many bearish analysts just don't get it about Facebook Inc. (NASDAQ:FB). Yes, the stock has a pretty high earnings multiple of 61 but this is most certainly not how you value this company. Amazon.com, Inc. (NASDAQ:AMZN) is in the same boat. Its earnings multiple is close to 200 but yet its share price keeps storming higher. Suffice to say that Facebook has intentionally decided to have the earnings multiple it has at present. This is what happens when a huge amount of capital goes back into the business every year. Just look at last quarter's numbers. Gross income came in at $5.52 billion out of revenues of $6.44 billion which highlights immediately the huge margins we are dealing with here. Furthermore, net income came in at $2.05 billion (see chart) which meant that 63% of gross income was one way or another pumped back into the company.
I also believe the argument of slowing user growth is another misnomer. Why? Because in the company's second quarter, Facebook delivered revenue growth of 59% despite monthly active users (MAU) only growing by 15%. The company is actually re-accelerating its top line in the face of slowing user growth. I believe this divergence will continue over time. Why? Because with the platform now closing in on 2 billion users using the site every month you can bet that Facebook will come up with ingenious ways of generating more revenue from its users. Is Facebook stock overvalued? - not by a long shot. In fact, this company is only getting started.
Sustained Increase In Engagement Levels Reduces Downside Risk
For investors who are worried about the downside in Facebook stock, all one really needs to do is look at the engagement levels which Facebook has been achieving. The best way to calculate user engagement is to divide the daily average usage by the monthly average usage in terms of time spent using the service. In the second quarter of this year, this metric showed strength as it gained 100 basis points over the second quarter in 2015. In fact, this metric is what investors should be focusing on in every earnings announcement. In Q2 we saw revenue per user grow by almost 40% due to the higher daily usage. What bearish analysts are missing here is the growth rate of mobile users on the platform. Mobile users reached 1.57 billion last quarter, which was a 20% hike on a rolling quarter basis. This means mobile users now make up 92% of total active users on the platform. Therefore as a result of the mobile trend that is taking place in the world, you can bet that daily engagement will definitely grow in the quarters and years ahead.
Targeting Will Become Even More Precise. Buy Options Will be Available On Mass Soon
Accepting that the strong mobile trend will drive engagement, it is still only the tip of the iceberg of where I believe Facebook is going with its data accumulation. Just think about this for a second. Facebook became the "go to" platform for advertisers when it was operating mostly as a desktop platform. Now with increased mobile usage and increasing engagement, Facebook engineers are going to know exactly what each user's interests, activities, hobbies, etc are at any given time. Highly relevant content which would include extremely targeted ads is going to be the future on mobile. Ad targeting is going to become so precise in that it will enable the ads to have buying options embedded in the ads. We already are seeing signs of this. Recently, Facebook announced that users will be able to buy directly from within messenger without leaving the platform. This can be done by placing a buy button within the app which means the user stays on the platform while the credit card transaction takes place. I can see this being rolled out across all of Facebook's platform which should attract advertisers in droves once we have numbers of its effectiveness.
Huge Amounts Of TV Advertisers Will Eventually End Up Spending On Mobile
Facebook knows that the two real growth areas for collecting advertising dollars in the future will be mobile and video. This is why it is working hard at present to convince advertisers how its targeted advertising is much more effective than the likes of TV advertising. There is no doubt that ad targeting is far more powerful online but proving it is another issue. Procter & Gamble have stated that have stated that they would move away some of their target advertising from Facebook (probably due to a technical error by Facebook) but I think this is something that will blow over quickly. Facebook Live, for example, hasn't even been tapped at present but will definitely end up gaining more advertising dollars from its clients. Facebook have gained 1 million extra advertisers since March of this year. Moreover, once advertisers begin to receive strong metrics from Facebook in terms of effectiveness as an advertising outlet, more and more traditional TV advertisers are going to make the transition to mobile. Facebook, in my opinion, is going to be first in line to pick up these advertising dollars.
Facebook stock will storm higher in the years to come. The fundamentals of mobile use combined with eCommerce will ensure advertisers will gravitate to its platforms on mass. $150 a share is definitely an achievable target for Facebook stock over the next 6 to 12 months.