- Facebook, Inc. achieved more expansion in its operating margins in its second quarter.
- Higher Engagement levels are resulting from growing daily usage.
- Facebook has yet to meaningfully tap revenue from WhatsApp & Messenger which will offset declining ad growth on Facebook.com.
Facebook's (NASDAQ:FB) second-quarter earnings were excellent especially at home where the US and Canadian regions reported ad revenue growth of 69%. Asia grew its top line by 67%, but the real story of the quarter was mobile as mobile revenue now makes up 84% of the company's ad revenue. The strong growth in the company's top and bottom line has resulted in its valuation metrics coming down. For example, its price to earnings ratio is now 59, which was well over 100 last year. Furthermore, its sales multiple has dropped from 18.6 last year to a healthier 16.1.
This is good from an investors point of view as sentiment levels are lower now than they were a year ago when the stock was much lower. I use sentiment as a contrarian signal as I don't like going long on stocks with a very high sentiment. Therefore here are 3 strong reasons to stay long this stock and use a trailing stop loss if needs be.
Facebook's Operating Margin Expansion Indicates That It Will Remain A Growth Stock
With Facebook stock price rising by 44% over the past 12 months, it means that revenue and particularly earnings are growing at a faster rate the stock price. Earnings, for example, have gone from $715 million in the company's second quarter last year to $2.05 billion in Q2 this year. With more revenue finally dropping to the bottom line, one could have made the case for Facebook finally turning into a value stock but this couldn't be further from the truth. Why? Well, although the company is guiding for slowing revenue growth both this year and next, operating margins continue to expand. Facebook's gross margin on a trailing-twelve-month (TTM) basis is now at 85.1% whereas its operating margin is at 39.6%. These are very impressive numbers when you consider that we are talking about a $355 billion company here. I see Facebook stock nowhere near its peak which is why investors should not be thinking of selling just yet.
Daily User Growth Will Drive Larger Spends From Advertisers
The reason why ad revenue grew by 63% despite monthly user growth increasing by 15% was down to one metric - engagement. We saw this in the daily user growth of 17% which resulted in longer times being spent on the platform by users. As long as daily user growth supersedes monthly user growth on a rolling quarter basis, it means engagement levels are increasing, which invariably will lead to higher return on investment for advertisers.
Bears have pointed to the fact that daily user growth in developed markets (such as the US & Europe) is much lower (9%) than the average but I don't see this as a huge threat to Facebook's revenue growth. I acknowledge that revenue per user in developed markets is much higher than developing markets such as the Asia pacific but I believe some analysts are underestimating the mobile initiative here. There are still 700 million users who are not hopping on to Facebook every day. Therefore, I believe the slowing trend of daily users in lucrative developed markets will be offset by the growth of mobile. Bulls have nothing to worry about here.
Slowing Ad Load Growth On Facebook Will Be Offset By Higher Engagement & Ad Load On Other Platforms
Moreover, management guided that revenue growth would likely slow in the latter part of the year due to "ad load" tapering off as a large driver of company revenue. I wasn't surprised by this comment and to be honest, it had to be coming. Facebook, up to this point, has been able to place more ads into users feeds without upsetting the apple tart. However, the rate of ad loads has been obviously faster than the rate of new users so present ad load growth will have to slow down. Why? Well, Facebook probably has tests done on this but ultimately it doesn't want to piss off its users. Will it make a difference in the near term? Probably, but I think management has done well in flagging this.
Will it make a difference in the near term? Probably, but I think management has done well in flagging this. Moreover, ad load growth can still take place on WhatsApp, Instagram & Messenger where there is ample runway for inserting ads. What I will be watching out for on the Facebook platform in the next few years is how well the company will be able to target its ads. Daily user growth will undoubtedly help and if Facebook can squeeze more revenue out of its users on a platform where ad growth is declining, it would be bullish for its other platforms where slowing ad growth is still a non-issue.
To sum up, Facebook has too many growth drivers to stop rallying now. The bears quickly targeted its slowing daily user growth in developed markets as well as slowing ad loads but these reasons won't slow down the revenue growth. The company's fundamentals remain strong. Stay long Facebook stock as there is more upside waiting here