It is extremely unusual to see a company with a multibillion dollar market cap trading higher than 10 times sales. Facebook (FB, Financial) currently has a market cap of nearly $369 billion, commanding a whopping 14.8 times sales valuation at the time of writing. It is easy to say the company looks extremely overvalued, but it is also extremely hard to put a number on the yet-to-be-monetized parts of Facebook, such as WhatsApp.
The market clearly has high expectations for the company because it is still growing its revenues at high double-digit rates. For the third quarter of 2016, Facebook posted sales growth of 56%, with growth in the first nine months of the year coming in at 55.77%. These are staggering numbers because Facebook’s third quarter revenues alone came in at $7.011 billion. It is very rare for a company approaching $10 billion in quarterly sales to post a 50%-plus growth rate.
Posting year over year growth is one thing, but posting quarter over quarter is completely different. It clearly shows there is massive momentum behind the growth, which will have to continue for some more time before coming down. Facebook’s quarterly numbers have been growing sequentially, sans the seasonal peak it keeps hitting during the fourth quarter every year.
Facebook earns money mostly through advertising, so revenue growth is dependent on two simple factors: how many users they add and how many ads they show per user. Facebook’s average revenue per user (ARPU) has grown tremendously over the last few years, but that growth may be reaching its peak. Facebook’s chief financial officer cautioned investors about future growth prospects due to the high ad load the company has already hit.
“Over the past two years, we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth,” CFO Dave Wehner said during the earnings call. “With a much smaller contribution from this factor going forward, we expect to see ad revenue growth rates come down meaningfully."
Clearly Facebook expects ARPU to start stabilizing in the future, which leaves sales growth numbers to be even more dependent on user base growth. Since Facebook is growing at such a tremendous pace however, a slowdown in the near future seems a distinct possibility.
During the third quarter, Facebook’s monthly active user base expanded by 16% compared to last year. Though much of that growth is coming from Asia-Pacific and the rest of the world, Facebook’s ARPUs in those regions were at a commendable $1.89 and $1.21 during the third quarter.
Even if ARPU slows down, user base growth will help Facebook post double-digit growth rates. It may not be at the same level as before, but definitely above average for a company that is approaching $10 billion in quarterly revenue.
The growth of Instagram will also help boost Facebook’s overall sales numbers, while no one, including Facebook, knows how much sales growth to expect from WhatsApp in the future.
The current growth rate, ever-expanding user base, the growth of Instagram and the unknown variable that is WhatsApp have jointly driven the stock to trade near 15 times sales. It is definitely not a comfortable place for an investor to be because it leaves absolutely no margin for error.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
Start a free 7-day trial of Premium Membership to GuruFocus.
