- Earnings and revenues show good momentum, but the future outlook may be overly bullish.
- Instagram is a great add-on to revenues.
- Facebook is trading at a significant premium to comparable companies, and while profitable, may be a "growth trap.".
Facebook (NASDAQ:FB) has made an impressive rally in last one year (up almost 36%), closing on September 23rd 2016 at $127.96 per share. While this increase can be attributed to strong revenues and profitability over the last year, we're going to take a closer look at what the future will look like for Facebook stock?
Earnings and Revenues Show Strong Momentum
Earnings per share and total revenues show a consistent increase in each of the past five fiscal years. Similarly, free cash flows have also shown strength, increasing during the same time frame, highlighting Facebook's strong financial performance. The company is currently generating a lot of cash, and many analysts have very bullish expectations of what is to come. This may be attributed to Facebook's over-performance on a range of metrics, among which are Facebook's one-year EPS growth rate of 44.5% with expected EPS growth rate over the next three to five years being 69%, much higher than relevant internet/tech competitors and technology sector growth rates. So Facebook is a growth stock with a lot of momentum, but what about its valuation? Does the recent rally leave plenty of stock price upside?
Valuation Is a Concern Now
While Facebook has very good profitability metrics, continuing to outperform the relevant sector benchmarks for both operating margin and profit margin, valuation metrics are also higher. Important ratios such as Price/Earnings, Price/Cash Flow, Price/Sales and Price/Book Value are all much higher than the benchmark industry ratios. This leads Facebook toward an earnings yield of 1.6%, which is much lower than 5.1% earnings yield for S&P 500.
Its "un-affordability" ratios compared with key industry peers of Facebook - Alphabet (NASDAQ:GOOGL), LinkedIn (NYSE:LNKD), Yahoo (NASDAQ:YHOO) and Twitter (NYSE:TWTR)) - stare investors straight in the face. Facebook has a higher Price/Sales ratio and Price/Book ratio than all four mentioned peers. Facebook's Price/Earnings ratio is higher than that of Google, with both LinkedIn and Twitter having a negative ratio. As this trend shows, as a whole, Facebook seems to trade at a very significant premiums both compared to its industry and sector averages, and to its main industrial peers. We are concerned that while Facebook shows strong profitability, the current stock price seems to be very rich on a relative value analysis.
Instagram and WhatsApp Can Possibly Add More Profitability to Facebook
Facebook has made several important acquisitions over last years to strengthen its dominant position in the technology sector and the internet of things. Adding Instagram and WhatsApp to its business and marketing properties can provide significant and diversified sources of revenue and profitability independent of Facebook's core business, as well as incremental revenue with the integration of these multiple platforms. While social media competition is growing in intensity, having an advertising-oriented revenue model requires Facebook to continue to exploit promising new sources of revenue to grow into the future. Such acquisitions are likely to be symptoms of what is to come in the future, as Facebook will continue to have the need for incremental, sustainable growth.
While Facebook has shown five years of impressive results in terms of earnings and revenues growth, and is considered a glamour growth stock, the recent one year stock price rally of 36% indicates that many of these future profits may be priced in at today's valuation, making this stock overly expensive on a relative value analysis basis.
Technical analysis shows a very bullish picture as the stock, both on daily and weekly charts, is above the 50 and 200 simple moving averages, which are also on a rising slope. The stock is finding resistance around $132 per share, but above that level there are no signs of significant resistance. The catalysts that can move the stock higher are mainly what sent stock higher last year - increased earnings per share and revenues. But we are concerned whether 3-5 years earnings growth of 69% is sustainable. While it is hard to ignore the strong financial performance of Facebook during last five years, we think at current levels the stock is not a buy.