Shares of Facebook Inc. have gained nearly 20% in 2017. Given the recent management commentary, is FB stock still a good buy?
Facebook (NASDAQ:FB) has quickly gone on to become one of the biggest technology companies of our time. Shares of the Menlo Park, California-based social media giant have tucked on gains of nearly 20% in the year-to-date. The strong rally in FB stock, combined with recent management commentary on heightened investments and lower profit margins, could force prospective investors to wait on the sidelines. However, FB stock could be on a bull run based on its strong fundamentals and current growth expectations. Evaluating the stock using a DCF model shows that the Facebook stock provides a big 'margin of safety' even at the latest closing price of $137.72 per share.
Facebook Growth Expectations
The single biggest driver of Facebook stock has been the rapid growth in the company's various financial metrics. As covered in our recent post, Facebook profits rose ~3X in FY 2016, which is no small feat. And, while we don't expect Facebook to deliver such extraordinary growth, there is still enough growth to drive the stock far higher from its current levels. The current Wall Street consensus expects Facebook to grow at an average annual rate of 23.5%, over the next 5 years. However, historical performance suggests Facebook could outgrow current expectations, which was evidenced by accelerated growth in FY 2016. We use the Wall Street consensus as growth inputs in our FB stock intrinsic value model.
Facebook Stock Intrinsic Value
We use a discounted cash flow model (DCF model) to evaluate Facebook stock. The various inputs for our model are:
- Year 0 FCF (FY 2016): $11.62B
- Year 1 Growth rate: 23.5%
- Growth decline Rate: 5%
- Discount rate: 8% (Facebook's WACC is 7.54%)
- Exit Multiple: 10
Based on the above inputs, we arrive at an Intrinsic value of $190 per share for Facebook stock. The stream of Cashflows and their discounted values are summarized below.
Facebook Margin of Safety
A 'margin of safety' is the difference between the intrinsic value of an asset and the current price of the asset. Since Intrinsic value calculations are, more often than not, based on estimates and assumptions, a margin of safety provides a cushion against errors in the assumptions/calculations. In other words, 'margin of safety' reduces downside risk. The higher the margin of safety, the greater will be the confidence of the investment decision. With this basic understanding of the concept, let's look at the intrinsic value of Facebook stock and evaluate what is the margin of safety offered at the current price levels.
As shown in our model above, the intrinsic value of Facebook stock as per our model came in at $190 a share. A 25% margin of safety implies a price of $142.5, which is still higher than the last closing price. The last traded price of FB stock provides Facebook bulls with a 27.5% margin of safety, which implies that Facebook stock is still a good buy for bullish long-term investors.
Facebook stock has been on a run, gaining nearly 20% in the year-to-date. However, the stock could be headed higher driven by multiple growth drivers like mobile ad revenue growth and explosive Instagram growth. The current ramp up in Instagram revenues and the incremental potential offered by a billion users each on Messenger and Whatsapp could propel Facebook above the current street estimates.
Based on the current growth estimates, which we believe are conservative, facebook stock is a good buy for ong term investors even at the current price levels. Hence, long-term investors should continue to accumulate Facebook shares and buy even more on every pullback in the FB stock price. FB stock is also among our Top Stock Picks from the technology sector which have outperformed the market by over 130%.