The recent net neutrality fiasco sparked furious debate between Democrats and Republicans, socialists and capitalists, economists and idealists and it also did so, surprisingly, among the students at my children’s middle and high schools. For the kids in our schools, the debate was focused mainly on whether their internet services would be “better or worse” or “more expensive or less expensive” because of the repeal. For investors, the net neutrality debate also led to discussions about what companies will benefit or suffer because of the change. Among the names mentioned both as a beneficiary and a victim of the repeal is Facebook Inc. (FB, Financial).
Perhaps surprisingly, among the articles and commentaries as to whether Facebook benefits from the repeal of net neutrality, was the suggestion it is a value stock. Can it be? Facebook? Value? Let’s see.
A handy, simplified definition of a value investment is the following: “A value stock is one which is trading for less than its intrinsic value.”
Simple and inarguable. Crunch the numbers, determine what the share price should be and buy the stock if the current market value is lower. We all, experienced investment advisors, portfolio managers and individual investors, preliminarily categorize stocks as value or growth, then do the work to see whether our initial impression is correct. Confirmed, we then make an investment.
Often value is found in companies that have stumbled recently, provoking an opportunity-creating overreaction, driving the share price below the true value of the company despite whatever bad luck may have affected the company. Astute analysts and investors identify the arbitrage opportunity and buy the stock on the cheap, happily reaping the rewards when the stock price eventually rises to parity with the company’s intrinsic value.
But can a stock like Facebook, one the has yet to really stumble, be considered a value while it maintains the growth track it has followed for years?
The forward price-earnings multiple is currently at 27 times, which is high by many value investing standards, but is inexpensive when considering Facebooks growth rates of 47% for revenue and 79% for net income in the most recent quarter.
Facebook reported $10.33 billion in revenue, which surpassed analysts’ estimates by nearly $500 million. Advertising revenue grew 49% year over year, reaching $10.14 billion during the period while mobile ad revenues were up 57% to $8.9 billion.
Facebook reported an operating profit margin of 50% of revenue in the third quarter of 2017 and $1.59 in earnings per share during the quarter, an increase of 77% versus the same period in 2016. Average price per ad increased 35% from the year-ago quarter and ad impressions grew 10%.
The company has cash and cash equivalents of $38.3 billion and cash flow from operations of over $6.1 billion. Free cash flow was nearly $4.4 billion.
Facebook conjures these numbers through its enormous user base of nearly 2.1 billion monthly and 1.4 billion daily active users. Other applications it owns also have huge user bases as well, including WhatsApp and Messenger at over 1 billion each and Instagram with more than 500 million daily active users. Facebook has grown this user base impressively with both daily and monthly active users growing by 16% annually.
As a growth stock, Facebook has done quite well. Since its initial public offering in 2012, the share price has risen from below $20 to $179, giving Facebook a market capitalization of $520 billion. Facebook reported $1.9 billion in revenue in 2010. In 2017, Facebook boasted $36.5 billion in sales on a trailing 12-month basis. Net income expanded from $606 million in 2010 to over $15.2 billion in 2017.
But can we declare Facebook to be a value play? If we agree the future looks nearly as rosy for the company as the past has been, then, yes, based upon current growth rates, the company might be undervalued today. But we must be practical. Buying it now carries different risk than it did a few years ago. For one thing, Facebook should gradually see growth slow simply because that is how the business cycle works for maturing companies and industries.
And that is fine. But the worrisome risk is in the unknown. If Facebook does not get pushed aside by the “next greatest internet thing” and it does not create an unexpected negative situation for itself, then the better term for Facebook is not “value” or “growth,” but “yes.” The company is doing quite well and should continue to do so for the foreseeable future. It is not a true value stock, and its growth might slow, but your portfolio should not be worse-for-wear with Facebook in it.
Disclosure: The author owns none of the stocks mentioned in this article.
