The market’s reaction to Facebook’s fourth-quarter earnings report was a bit unusual.
Facebook (NASDAQ:FB) beat revenue and earnings estimates in the quarter, yet instead of rising on the news, the tech stock plunged after hours Wednesday and remained down 7% in pre-market trading Thursday morning.
Coming into the quarter, analysts had expected slowing growth as the company has continually forecast, but the social media giant still delivered solid results.
Revenue jumped 25% to $21.1 billion, ahead of estimates at $20.9 billion, while earnings per share, which was affected by a higher tax rate, rose 8% to $2.56, edging out estimates at $2.53. Some investors seemed disappointed that the company didn’t beat guidance by a wider margin, which seemed to prompt the sell-off.
Image source: Facebook.
Heading to value range
Based on Facebook’s after-hours trading price around $207, the stock’s P/E ratio was just 24.2, adjusting for the $5 billion in FTC fines Facebook was assessed in 2019. That’s slightly below the S&P 500’s P/E at 24.6. Backing out Facebook’s $54 billion in cash and equivalents, the company’s P/E ratio is closer to 22.
The overall stock market is frothy, despite average earnings that have declined slightly through the first three quarters of 2019 due to challenges in the energy sector.
Facebook, by contrast, is one of the most consistently reliable growth stocks on the market. The company’s revenue growth slowed to 25% in the fourth quarter, its slowest ever, and that deceleration is expected to continue as it matures and as regulations have made targeted advertising more difficult. Nonetheless, Facebook will continue to outgrow the S&P 500 for the foreseeable future, and likely by a wide margin.
Additionally, the company has a bulletproof balance sheet, no exposure to China and the trade and coronavirus risks that entails, and a nearly unmatched set of competitive advantages, making it significantly less risky than a lot of stocks on the S&P 500.
Why the market is skeptical
As Rodney Dangerfield might say, Facebook can’t get no respect. There seem to be two primary reasons that the stock is trading at a discount to the S&P 500, despite its evident strengths and rapid growth rate.
First, Facebook carries a certain degree of regulatory risks, as well as the potential for backlash from the general public. The $5 billion in fines Facebook faced from the FTC last year and multiple threats from European bodies show the company could be forced to pay further fines as privacy regulations tighten. Meanwhile, presidential candidates like Elizabeth Warren have also threatened to break up the company due to what many see as monopoly-like power.
Facebook cost itself significant damage to its reputation in the 2016 election as Russian hackers used the platform to manipulate voters, and Cambridge Analytica was able to obtain private data on voters without their permission. With 2020 being another election year, Facebook’s response to such threats is going to be closely scrutinized by regulators and the media. Already, the company has garnered criticism for refusing to take down political ads with misinformation in them.
The second reason for investor skepticism is the slow deceleration in Facebook’s growth rate, a function of the company’s size, limits to ad load, and the law of large numbers.
Facebook CFO David Wehner said the company’s revenue would decelerate in the low-to-mid single digit range in the first quarter from the fourth quarter, meaning it’s likely to come in the low 20% range, though its guidance has been conservative in the past.
He explained, “Factors driving this deceleration include the maturity of our business, as well as the increasing impact from global privacy regulation and other ad targeting related headwinds. While we have experienced some modest impact from these headwinds to date, the majority of the impact lies in front of us.”
There’s plenty of growth left
Despite those challenges, investors are mistaken to think that Facebook has simply become a boring digital ad business. The company has a number of potential levers for growth, including Augmented Reality and Virtual Reality, payments, Instagram commerce, and new ways to advertise (in its Stories, for instance).
For instance, CEO Mark Zuckerberg shared on the call that sales of Oculus Quest have been stronger than expected, and that it sold nearly $5 million worth of content from the Oculus Store on Christmas Day — which is an “outlier day” — but those numbers are still meaningful.
In payments, the company has been testing WhatsApp Payments in India, and is planning to roll it out to other countries over the next six months, giving it the ability to grab a piece of an industry worth hundreds of billions, if not trillions, of dollars, according to different measurements.
Finally, the company has been slowly ramping up Instagram Checkout, and now has hundreds of businesses using the new tool. Shopping directly on Instagram seems like a natural extension of the app, as it’s already often used for discovery, or finding out about new brands and products — so it makes sense that businesses would want to sell directly through the app. Shoppers, meanwhile, love the convenience.
With those opportunities and others, including Facebook Marketplace and Dating, the company should be able to find new ways to grow and become even more relevant for its users.
Considering its growth rate, competitive advantages, and future opportunities, Facebook stock looks like a bargain following the post-earnings sell-off, trading at the same valuation as the broad market.