Facebook (FB, Financial) is a high-growth stock with the opportunity to create massive value for potential investors. Value investors have to be able to look beyond price-earnings (P/E) ratios and look at the underlining economics of the business.
Some of Warren Buffett (Trades, Portfolio)’s best investments were when he paid four times net tangible asset or 20-plus times P/E for a business. Clearly Buffett and Charlie Munger look beyond P/E ratios.
Why would a value investor think of investing in Facebook and writing an article about it? That is the question I’ve been asking myself for a few weeks. I’ve read everything I can find on Facebook from its financial statements to other articles written about the company. After spending more time then I had to, I’ve learned Facebook is a strong growth stock that is still growing rapidly. A company with a $300 billion-plus market growth at double digits is shocking since only a few large companies can achieve that kind of growth rate. This creates great opportunities since Facebook is still growing its business value at a high rate.
Based on P/E ratio and other traditional value metrics Facebook looks grossly overvalued. However, sometimes a company looks overvalued when in reality it's undervalued. Facebook will easily sell in the high $700 per share range 10 years from now.
Overview
Thanks to the leadership and genius of Mark Zuckerberg, Facebook has seen massive growth on all fronts. He has acquired both Instagram and WhatsApp over the last few years for prices that shocked the market and analytics. Facebook operates a social networking web site with 1.7 billion users. The company’s products are Facebook, Instagram, Messenger, WhatsApp and Oculus.
Facebook’s products enable people to connect and share through mobile devices and personal computers. Third quarter net income increased 166% and diluted earnings per share increased 165%. Facebook reported 56% growth for total revenue and has 1.65 billion mobile users. Over 50% of Facebook's active users access the site through mobile devices.
Facebook's business segments
- Facebook site – 1.7 billion users.
- Messenger – 1 billion users.
- WeChat – 1 billion users.
- Instagram – 500 million users.
Through Facebook’s various sites and mobile application the company has create a large economic moat to protect and expand its adversing base. Facebook has been able to continue to grow its users base despite competitors like SnapChat and Twitter (TWTR, Financial). Both have failed to overtake Facebook as the largest social networking site in the world. This proves that Facebook has a strong and deep competitive advantage over its competitors.
Advertising
My mid-2017 Facebook will see its ad load hit its peak meaning the company won't be able to grow revenues through expanded ads on Facebook’s sites. Despite reaching peak ad load Facebook's average revenue per users continues to rise. At the end of 2016 Facebook controlled of 20% of the online ad market with Google still controlling the vast majority thanks to its search engine. The company is still in the early days of monetizing WhatsApp, Instagram, Messenger, and Video. Facebook has announced that now Messenger users can send money to one another or to businesses.
Clearly Facebook is looking to maximize revenue growth through ads or other ways. Facebook continues to see its advertising ecosystem grow with the company having 5 million active advertisers and 1 million active advertisers on Instagram.
The company has begun to monitize WhatsApp with the company planning on launching a peer-to-peer payments on its platform in India. WhatApps starting to monitize is platform through payment will allow the company to continue revenues growth given with Ad growth slows down.
Valuation
Facebook is selling for a high valuation which can an not not be justifed based on its growth rate in return on invested capital. Over the last five years Facebook has been able to reinvest its capital at a far higher rate then most businessiess would ever achieve. However, this massive returns across the board can't continue forever. Like Google, Facebook is a giant in the advertising market with over 20% of the online advertising market. The company is still adding advertisers and beginning to monitize WhatsApp through payments.
One of Facebook's competitors abroad Tencent Holdings (TCEHY, Financial) owns the giant WeChat, which has been proving peer-to-peer payments for awhile now. The company's WeChat has been ahead of WhatsApp which gives use the ability to see potentially what Facebook's WhatsApp could produces in earnings, growth and revenues. As of the fourth quarter Tencent saw payment and clould revenues growing 289% year over year to 6.4 billion renminbi ($929.08 million).
The company also reported 600 million mobile payment active users and 600 daily average payment transactions. Facebook's potential could see the same number as Tencent. Montization through payments could increase Facebook revenues annually by $1.5 billion. This is based on Tencent numbers its produced in 2016 in the fourth quarter.
I can see Facebook selling 10 years from now at $700 plus per share based on its growth trends and ability to compound return on capital at above 20% annually.
Disclosure:Â The author has no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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