Given the hypes and the kind of skyhigh valuations we see in the market these days, I think that Facebook stock is considered very decently valued as an established tech giant.
Source: Facebook Annual Report FY2020 / Consolidated Statements of Income
Based on the latest earnings report for FY2020, Facebook’s earnings works out to be $10.09 per share.
At a share price of around $270, that means Facebook stock is trading at around 27 times earnings.
That’s a relatively low multiple for a tech giant growing revenues and earnings at around 20% per annum for the past few years.
The question is, can the company continue to grow at this rate?
And what kind of risks do investors need to be aware of?
Headwinds and Potential Downside of Facebook Stock
First, understand that there is mainly one critical headwind that the company is facing. This is also the potential reason why Facebook is not trading at higher multiples because of the risks it is facing.
Apple iOS Update
This is related to Apple rolling out its new iOS operating system that limits advertiser’s ability to use data.
Source: business2community / Here’s What the iOSS 14 Update Means for Your Facebook Ads
Apple will now require all apps to prompt users requesting permission from users for the app to track them outside the platform. And we expect substantial users of iphones to opt out of this.
In simple terms, Facebook may not be able to show personalized ads at the level they are providing now, due to the limited data of users’ activities moving forward.
Yes, this is definitely going to dampen the advertising experience for users by hampering Facebook advertising capabilities.
Impact of Apple iOS Update
But let’s put that into perspective.
Source: Statista / Mobile operating systems’ market share worldwide from Jan 2012 to Jan 2021
First, understand that Apple iOS accounts for about 27% of the mobile operating system worldwide. Other other hand, Google’s Android accounts for the majority 72% of the market share.
Therefore, this will not impact the majority of the users, the ones who are on the Android operating system.
However, that’s not to say that the 27% share of Apple iOS is not significant.
But then again, if you think about it, Apple’s iOS update will impact the whole industry equally. Meaning that all kinds of apps which are providing advertisers the platforms to reach their audiences will all be impacted.
What this means is that Facebook remains the best platform in town. Even if the level of personalization is lesser moving forward for iOS users, advertisers will have no choice but to continue using Facebook to reach their audience digitally.
So, I think this iOS update causing fears that Facebook will lose a chunk of ads revenue is overstated.
Moreover, ad spending is going to rebound in 2021 after the extraordinary year we had with the coronavirus pandemic in 2020.
We will see ad dollars continue to migrate to the digital channel, with heavier usage of digital applications.
Facebook Stock Recent Earnings And Performance
In fact, Facebook’s recent report for its fourth-quarter earnings of 2020 already showed signs of progress. Seems like the pandemic is not slowing down its business after all.
Source: Facebook Earnings Presentation Q4 2020 / Advertising Revenue by Facebook User Geography
Compared to Q4 2019, Q4 2020 saw a 31% increase in revenue to $27 billion.
Other metrics were positive as well.
Source: Facebook Earnings Presentation Q4 2020 / Facebook Daily Active Users (DAUs)
Facebook daily active users has increased by about 11% to 1.845 billion users in Q4 2020, compared to the same quarter in 2019.
Source: Facebook Earnings Presentation Q4 2020 / Facebook Monthly Active Users (MAUs)
Similarly, its monthly active users has also increased by about 12% to 2.797 billion users in Q4 2020 compared to Q4 2019.
Source: Facebook Earnings Presentation Q4 2020 / Family Average Revenue per Person (ARPP)
What’s better is that, the average revenue per person has increased by a higher percentage of 16.8% to $8.62 in Q4 2020 when compared to Q4 2019. This is higher than its daily or monthly active users’ growth rates.
This means that there’s higher ad spending on the platform. Whether it’s because of the shift from traditional media or from other competitors. Either one, it’s good news for Facebook.
So, from all these performance reports, it shows that Facebook’s position in the market remains strong. It is unshaken by the pandemic effect when many businesses are lowering their marketing budgets.
Now the question is, can it maintain its growth trajectory?
Facebook Stock Potential Upside
Well, first understand that digital ad spending is going to increase going forward.
More importantly, recognize that ad spending is going to continue to shift away from traditional media towards the new digital media.
Source: Statista / Advertising media owners revenue worldwide from 2012 to 2024
Observe that the projected total advertising spending, in both traditional and digital media, will increase from $578 billion in 2020 to $763 billion in 2024. This translates to a 32% increase over the 4 years period.
Source: Statista / Digital advertising spending worldwide from 2018 to 2024
Conversely, digital ads spending is projected to increase from $333 billion in 2020 to $526 billion in 2024. This represents a 58% increase over the same 4 years period. This is higher than the overall ads spending growth of 32%, signifying a continued shift towards digital advertising.
This means that Facebook should be able to at least grow organically with the digital ads spending growth at around 12% compounded annual growth rate (CAGR) over the next few years.
Source: Nasdaq / Facebook Yearly Earnings Forecast
And this is quite close to analysts’ earning forecast. Average consensus earnings per share is forecasted to grow at 15% CAGR from $10.09 in 2020 to $17.89 in 2024.
Based on the 15% CAGR for the next 5 years, Facebook’s earnings will hit $20 a share in 2025.
Using a 20x multiple, the company’s target share price should hit $400 in 5 year’s time.
Other Growth Elements of Facebook Stock
Source: Facebook Annual Report FY2020 / Revenue Breakdown
Other catalysts that can boost Facebook’s bottom line comes from the company’s bets and experiments are lumped together under its “Other revenue” segment.
This other revenue consists of revenue from the delivery of Facebook Reality Labs (FRL) consumer hardware devices, net fees received from developers using their Payments infrastructure, as well as revenue from various other sources.
Facebook does not provide more details about this segment. But the company did reveal some details on its Virtual Reality (VR) products Oculus’ sales every now and then. So we can say that its Oculus hardware and related software sales are the ones contributing mainly to the other revenue segment at this point in time.
Impressively, this other revenue segment grew an astounding 72% year-on-year in 2020.
Well, this could have been an effect of the pandemic. We saw a surge in usage across many gaming platforms during this period. And Oculus, which is targeting the game industry, is definitely getting a boost from this increased demand.
While we are not sure if the growth is sustainable, and to what extent can it grow, any positive surprise from these other bets, whether from Oculus or its other innovations, will definitely lift Facebook’s share price even higher moving forward.
So, to wrap it up, I’m definitely going to add Facebook stock to my watchlist. And if the target share price is of good returns for you, do consider adding to your portfolio as well.
Key risk apart from the Apple iOS update as discussed, will be the continuing episodes of antitrust lawsuits that the company is facing from the Federal Trade Commission (FTC) and other states.
Well, it’s not the first, and it won’t be the last. Many other tech giants like Google and Amazon are also facing pressures and constantly in the limelight of antitrust cases.
In the past, other companies like Microsoft faced such antitrust lawsuits before as well, and was settled with certain restrictions imposed and fines.
Anyway, the company’s Facebook platform is still its key advertising avenue. So, if in the end they are really required to break up with Instagram and Whatsapp, the company should still be able to survive well.
While it is difficult to assess the exact impact, i think it is not likely to have a devastating effect on its business in the long run.
But definitely something to keep in mind for us investors.
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