Facebook (NASDAQ:FB) is scheduled to report its second-quarter earnings tomorrow. Given the bumpy ride that FB stock has endured over the past year, investors are understandably nervous heading into this earnings report.
After FB endured more bad press, including the tragic New Zealand shooting last month which was live-streamed on Facebook, there’s a lot of negativity towards FB stock at the moment.
However, in reality, there isn’t too much cause for concern about Facebook stock. Expectations for FB are really low at the moment.
The rebound of FB stock from $125 to $175 has been driven largely by the broader market. The FAANG stocks in general are having a fantastic 2019 so far. The NASDAQ is already making new all-time highs, whereas Facebook is still more than 20% down from its peak. While tech has surged, FB stock in particular has done nothing of distinction. It’s not hard to see why: FB remains dogged by scandals.
The Scandals Were Damaging
I’ve warned about the potential impact of political scandals on Facebook stock in columns on InvestorPlace dating back to 2017. I suggested that Facebook’s profit margins would fall because the company would be forced to hire more humans to improve its policing of the platform. That is precisely what happened, as the company’s cost inflation surged because it hired tons of new employees. That offset last year’s revenue growth, and led investors to wonder if the best days of FB stock were behind it.
Even with the election now far in the rearview mirror, more scandals keep popping up. Just this past week, we heard about Facebook accidentally uploading as many as 1.5 million users’ email addresses inadvertently. At this point, scandals and outrages involving FB happen so frequently that we’re almost becoming indifferent to them.
But the ongoing cost of regulatory compliance and better tech policing will be high. FB has dug itself a hole in terms of credibility and reputation, and it has a lot of work to do to get out of it. All that being said…
Rumors Of Facebook’s Death Were Premature
All the uproar over Cambridge Analytica and Facebook’s numerous other scandals risks could cause investors to lose sight of the bigger picture. Last year, despite all the bad publicity, Facebook’s revenues surged 38% compared to 2017. Overall, its revenues jumped from $41 billion to $56 billion over the past year. Remember that as recently as 2013, Facebook generated annual revenue of less than $10 billion. Additionally, its WhatsApp and Instagram platforms continue to grow at lightning speed, setting the stage for more rapid revenue growth in years to come.
Even the old workhorse, the Facebook website, is still showing sizable user growth. It’s easy to get the wrong perspective if you live in the United States. Many Americans believe that everyone is abandoning Facebook over the election scandals and privacy concerns. But the vast majority of Facebook’s user base doesn’t care about the company’s role in American politics.
Moreover, Facebook’s user growth is coming primarily from Asia and Latin America, and its scandals matter little in those markets. Hardly anyone where I live (South America) is quitting Facebook due to the controversies. Put another way, Facebook has more than two billion users who don’t live in North America.
At the end of the day, there are still only two major online advertising platforms that have the reach and scale to appeal to most major brands. Those are Google (NASDAQ:GOOGL) and Facebook. As long as Facebook and Instagram ads deliver sufficient return on investment, their advertisers aren’t going anywhere. And with Facebook’s user base still growing, despite all the political outrage, its advertisers can’t abandon the platform.
The Verdict on FB Stock
Heading into Facebook’s earnings, the owners of FB stock have a win-win situation materializing. Either the company beats (low) expectations, leading to a sharp rally of Facebook stock. Or FB continues to suffer short-term pressure due to the ongoing costs related to cleaning up its various recent scandals. Any such dip would represent a big buying opportunity.
It’s important to remember that Facebook now has around $40 billion of cash on hand. On the other side of the balance sheet, it has no debt. That gives it tremendous firepower to buy back loads of FB stock if the price of Facebook stock dips again. Additionally, FB will likely start paying a dividend at some point as its cash reserves keep piling up.
The valuation of FB stock is more than reasonable. Facebook stock is selling for just 24 times its trailing and 20.5 times its estimated forward earnings, despite the considerable rebound of the share price so far this year.
Analysts predict that the company’s earnings will increase by an average of 17% per year over the next five years. If that scenario materializes, its EPS would more than double, getting close to $20 per share in 2025. Throw in the company’s debt-free balance sheet and massive cash pile, and it’s hard to see FB stock staying under $200 per share for very long.
At the time of this writing, Ian Bezek owned FB stock. You can reach him on Twitter at @irbezek.
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