Facebook (FB) is a name that I loved seeing go on sale after its IPO, because of the opportunity I see for the shares long-term. But sales don't last forever. Over the last several weeks, capital flows have clearly turned in Facebook's favor and should continue to support the shares moving forward. The announcement Wednesday that Facebook would be added to the Nasdaq-100 on December 12 highlighted one major reason for flow favor. Though, the capital flow support for FB is three-fold in nature, and is deriving from:
1 The expiration of trading restrictions
2 Tiring capital loss tax selling
3 Demand at index and other funds on the stock's rising status as a core holding for portfolios
Underachievement brought the stock back down to earth after its IPO built in high expectations. Management missteps and underwhelming operating performance have unfortunately become commonplace today among new Internet players. Overly hyped technology plays like Zynga (ZNGA) and Groupon (GRPN) have done far worse than Facebook, but perhaps investing historians can remind us of similar mistakes made at Microsoft (MSFT) or Apple (AAPL) in their early days of operation. Management missteps remain concerning for long-term considerations, but the profit opportunity available via the Facebook channel is simply too appealing for me to abstain from forever. The stock's appeal was again revealed when capital flow drags were cut loose over the last month or so. With capital flows now working in Facebook's favor, I strongly recommend the shares without restraint as a core holding for basically all portfolios.
Of course we know that many high flying technology names will not soar for long by nature. With regard to the players of today, in June, I exposed one important reason why the stocks were all overvalued, and the shares of some are down sharply since. I highlighted the importance of member counts to share valuation, and the fact that a good portion of the accounts listed proudly by many internet names were actually controlled by spammers or people who had more than one account. Thus, the valuations of the stocks were inflated.
Company & Ticker
June 27 - Dec. 5 2012
In a previous report, I also offered a suggestion to Facebook's management team to help it stabilize its shares. Based on the actions that followed, perhaps they noted and even considered them. I believe the Facebook team better understands now how to support its shares and most efficiently squeeze juice from the orange. However, I expect that even if future missteps ensue, the company's management team could stumble over itself and still book stellar profit growth.
The mobile challenge is an issue facing every Internet content provider today, and Facebook is not exempt of it. The company needs to better capitalize on its enormous user base, and to do so where they use the Facebook, including on the mobile platform. In that regard and in its efforts to better monetize Facebook on fixed computing devices, I have faith in the company's ability to do so. I do not think it even has to do much to exploit its opportunity, given the exponential benefits available to even the slightest income producing initiatives spread across the company's massive member base. It was Facebook's opportunity and widespread usage that pulled investors to it in the first place. Investors are once again seeing that opportunity in Facebook. And critically driving the shares now, concern is also fading regarding capital flow dynamics, especially since the company has passed important periods of shareholder selling restrictions.
Capital Flow Favor
The capital flow situation is changed now in the company's favor, whereas up until recently, capital flows and concerns about them weighed down share performance. The expiration of trading restrictions for a large number of early stakeholders has come to pass in recent weeks. 800 million shares were freed up in mid-November, which not coincidentally marked a turn for FB shares. FB is up 39% since its November 13 close at $19.86. Investors are now less fearful of stalking selling pressure weighing against their interests or potential interest in FB, and so they have begun to take stakes in greater numbers. I see more than one capital flow factor playing an important role in supporting the stock here though.
The selling of the shares for the purpose of capturing capital loss tax benefits has likely been exhausted at this point, with smart money having already capitalized on tax break opportunities in the shares. Those same institutions are now more likely buying Facebook again rather than selling it. Institutions running on fiscal year October and December closings would have sold the shares by now if they were going to. However, those same institutions remain well aware of the revenue and profit growth opportunities ahead for Facebook, not to mention its discounted valuation. They would want to use recent weakness to reestablish positions in what will likely be a mainstay holding for most institutions over the next few years.
Finally, Wednesday's announcement that Facebook would be added to the Nasdaq-100 just reminds us of the massive capital support these shares will have over the long-term. So, investors who may be fearful that long time holders of the shares might sell to free up captured wealth should be reminded that there will be adequate demand for the shares as institutions take their stakes. Index funds must add the shares when they are added to an index, and the capital involved in that process is substantial.
On an operating level, recent corporate announcements have reignited excitement about the advertising revenue opportunity, and analysts have begun ratcheting up earnings per share estimates accordingly. Based on data at Yahoo Finance, over the last 60 days, the consensus EPS estimate for 2012 is up 8%, while the number for 2013 is up 5% to $0.65. At that level, and while trading at approximately $27.50 momentarily, FB sports a P/E ratio of 42X its 2013 number; at $20 a few weeks ago, the shares were priced 31X that same figure and were obviously more appealing. Still, I expect the company's long-term EPS growth to exceed the current forecast of analysts, now conservatively set at 27%, which places the PEG ratio at 1.5. That is a high value on an absolute basis, but for a high growth company, it could still produce outsized returns against the broader market even if that growth rate were not surpassed.
Based on my expectation that EPS estimates and results will draw a trend of steady increase and outperformance moving forward, and considering the growth outlook, I expect the shares to earn and support their current valuation and rise appropriately next year and over the long term. So, if a 1.5X PEG ratio can be sustained, and growth can satisfy investors' valuation, then the stock can at least grow at 27% next year. So, a 12-month target price of $35 seems within reason and possibly conservative. Regarding risk, of course, with its lofty valuation, the stock will be sensitive to its own operating performance and the impact of changes to the broader world. Any further missteps would be appropriately reflected in renewed sharp penalizing of the shares, though for long-term holders, I expect those would be overcome soon enough. In conclusion, now that capital flows are positively in Facebook's favor, "friends" of mine should be in the stock as well.