What is the key thing to watch? Revenue deceleration
Am I buying the stock now?
Facebook stock price (NASDAQ: FB) questions are running all over the internet in these days. What I want to discuss here is: why is Facebook’s stock down, I’ll show you a few earnings and valuation models that explain the movement in Facebook’s stock price, I’ll give you its fair valuation based on growth and I’ll give you the perspective of a practitioner, as I have been recently testing a bit with Facebook ads for my book and stock market research platform, which might be a bit more positive for the stock than what others show.
We’ll finish with a discussion on whether Facebook is a buy now and whether will I buy this for my model portfolio.
Here is the video for those who prefer that:
Facebook stock price and adds price – the growth story
Facebook disappointed investors on slower user growth, higher costs and slower guided growth but somehow, I feel investors are focusing on the wrong things here. Investors focusing on the wrong things has been the case since Facebook’s IPO, if not, the stock wouldn’t go from $20 to $220.
Cambridge Analytica and the current Facebook stock price drop
The previous stock price drop was just a temporary dip on the Cambridge Analytica scandal while the current drop is due revenue deceleration. This is what the company had to say in the last earnings call:
When investing in growth stocks it is all about revenue growth and when growth oriented analysts hear about revenue deceleration, they panic. Let me show you this on a few models.
Facebook stock earnings model
Here is my small earnings model showing expected earnings growth of 20% for the first 5 years and growth of 10% for the subsequent 5 years with a discount rate of 15%. 15% is my minimal required rate of return and that is why I used it. This is also the rate that I use to compare all my investments.
The present value is $127 but small adjustments in the growth rates change immediately the present value.
If I change the growth rate to 30%, from 20% in the first 5 years, the present value increases 50%. This big increase is why people panic when they see growth deceleration and that is exactly what happened with Facebook.
So, the question is what will be Facebook’s future growth? The biggest expert on social media that has been displacing Madison avenue over the past few years, Gary Veynerchuk says that Facebook add prices will grow 4 fold in the future.
Futher, my calculations lead me to believe that there is a 400% potential increase in Facebook’s revenue just from the current add costs. I recently boosted a post on my book for 15 EUR and reached more than 1,500 people. This is insanely cheap.
The cheapness will not last long as the number of adds on Facebook is limited. I expect there a quadrupling of price at least over the next decade. That is already 15% growth just from that.
Add 10% of growth coming from Instagram stories monetization, WhatsApp or something new like AR, VR or who knows, and you are quickly at 25% growth over the next decade. This would make FB’s stock undervalued now.
With a 25% growth rate over the next 5 years, followed by a 15% growth rate over the next 5 years, my present value for Facebook ends up at $176. Which makes it a buy at these levels.
VR, audio and whatever else will be out there in the next 10 years, Facebook store etc. all the opportunities that Facebook will have to leverage on its user base are not included in this and left as an upside. The same way things like Instagram were not even included in the 2012 IPO analyses and WhatsApp is not even monetized.
How much Facebook in Your portfolio?
People always ask me what stocks are a buy and what are not. I don’t know the answer to that question as every stock has to be part of a portfolio. This is my portfolio and Facebook will make 3% of it for now.
PORTFOLIO ALLOCATION – GREAT BUSINESSES ACROSS:
20% DEVELOPED markets and global (FACEBOOK 3% – to increase to 5% if further decline)
8% ASIA (incl. Russia)
8% HEDGES & GOLD
8% REAL ESTATE
25% – CASH AND OPPORTUNITIES
The reasoning behind that is that there is always a recession hanging above such stocks which could make them even better buys in the future. So, a balanced exposure and constant coverage is key to analyze the risk reward.
Risk/reward of investing in Facebook now
If facebook delivers 30% growth over the next 5 years and 10% growth over the subsequent 5 years, the present value is $182 with a 15% discount rate.
With a 10% discount rate we are already at $265.
In case of 10% growth and with a 15% discount rate we get to $76, implying a 60% downside.
So, a business offering returns of 15% due to the discount rate with only 60% downside and the potential for those returns to be much bigger and 2.5 billion users is something I like to have my portfolio exposed to.
Facebook will be one of the 4 to 5 great businesses I will own in the developed world.