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The investment community is having a difficult time assessing the value of Facebook (NASDAQ:FB). I on the other hand believe that the stock is likely to do extremely well over the next 5-years. I also believe that investors are under-estimating the long-term potential of the stock.

Fundamentals

Source: Information pertaining to Facebook came from the shareholder annual report, with additional information from the Facebook quarterly report, and YCharts.

Many overlook the fact that the company itself has been to expand the amount of cash it generates from its operations. Between 2009 and 2012 the amount of cash from operations has increased from $155 million to $1.6 billion. This has been astronomic growth.

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Between the 2011 and 2012 period the company was unable to improve cash from operations by much, this was because of a sudden increase in share based compensation in Q2' 2012, due to the company going public based on the graph below.

(click to enlarge)The operating margin suddenly declined by 63% in a single quarter, this was because of share-based compensation expenses and is likely to be a temporary phenomenon. This is why analysts have a consensus EPS estimate of $0.57 per share for 2013. Barring any unforeseen circumstances it is highly likely that the stock will be able to recover its EPS in 2013.

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Many members of the investment community have been heavily disappointed in Facebook's profitability and point to a variety of reasons for why Facebook is an awful investment. One prominent example of this is Stone Fox Capital which states that:

While analysts and the media continue to obsess about mobile revenue growth, a big issue that has popped up and remains is the huge increase in costs. While revenue only increased 40%, non-GAAP expenses increased by 67% over last year to $849M. The company grew headcount by 44% over last year to 4,619 at the end of 2012. All of the new products including mobile, Graph Search, and Facebook Ad Exchange added to revenue, but it all came at a huge cost.

The increase in expenses occurred because of the sudden increase in share related expenses. This means that the 0.63% profit margin is likely to be a temporary phenomenon and should not be looked at as a reason for why investors should no longer invest into the stock. The company's investment into expansion is a standard practice for growth companies, and using that as a reason for why investors should ignore the potential in the stock is fool-hardy.

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Share based compensation in Q2 2012 was $1.1 billion, so using statistics that run by trailing twelve months data would show that Facebook has done awfully in terms of profit margins, but because the duration of this phenomenon is likely to be temporary, the trailing twelve month indicators are over stating the negativity surrounding the profitability of the stock. Since many analysts use the TTM as a standard form of representing historical accounting data, it becomes difficult for the everyday investor to be discerning when it comes to reviewing the financial strength, and growth metrics of the stock. Since the profitability has been significantly affected by the share-based compensation expense, almost every ratio based metric will have an awful rating on the stock.

Technical Analysis

Facebook has sold off since its announcement of 4th quarter earnings. Because of the sell-off it appears that there's a compelling opportunity to accumulate shares in Facebook.

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Source: Chart from freestockcharts.com

The stock is trading above the 50- Day Moving Average while trading below the 20- Day Moving Average. The Stochastic rating on the stock is 13.11 meaning that the stock is over-sold. The technical analysis indicates that the stock may pivot from $29.05 per share. This can be seen as a great entry-point for investors and traders.

Notable support is $20.00, $25.60, and $28.00 per share. Notable resistance is $32.50, $36.69, and $42.00 per share.

Quantitative Analysis & Strategy

Analysts on a consensus basis have high expectations for the stock based on the table below.

Growth Est

FB

Industry

Sector

S&P 500

Current Qtr.

N/A

13.80%

N/A

9.40%

Next Qtr.

16.70%

48.30%

1994.50%

16.60%

This Year

7.50%

23.00%

40.90%

8.90%

Next Year

36.80%

27.20%

20.70%

12.50%

Past 5 Years (per annum)

0.00%

N/A

N/A

N/A

Next 5 Years (per annum)

29.19%

19.24%

17.47%

8.57%

Price/Earnings (avg. for comparison categories)

49.31

11.46

15.05

15.13

PEG Ratio (avg. for comparison categories)

1.69

1.82

1.63

2.01

Source: Table and data from Yahoo Finance

Analysts on a consensus basis have a 29.19% EPS growth rate forecast for the next 5-years.

I believe that the business will be able to recover and generate a reasonable amount of profit from its operations. I back this assumption using a proprietary model I have developed for forecasting the value of stocks.

(click to enlarge)Source: Forecast and table by Alex Cho.

By 2018 I anticipate that the stock will generate $2.37 in earnings per share. I remain optimistic because the company is well-positioned to grow internationally. I believe that future cost-cutting will generate reasonable improvements in net-income. Eventually the stock will surprise analysts estimates by a very large margin when given enough time.

(click to enlarge)

Source: Forecast and graph by Alex Cho.

The company is a phenomenal investment for the long-term. I anticipate FB to deliver upon the price and earnings forecast despite the risk factors (competition, economic environment, balance sheet factors). Facebook's primary upside catalyst is improving economics, international growth, and managing costs. I anticipate the company to deliver upon my forecasted price target of $128.06 by 2018. This implies a return of 340% by 2018. This is an exceptional return on investment for an online services company.

A higher yielding investment opportunity albeit having higher risk is to buy the Jan 17, 2015 calls at the $32.00 strike. The call premiums trade at $5.72. The price forecast for the end of 2014 is $42.18. The rate of return if the calls expire at $42.18 is 78%, the option will break-even when the stock trades at $37.72.

Conclusion:

The social network is rapidly growing because no one wants to be left out of their circle. Which is why the trend is your friend.

The conclusion remains simple: buy Facebook.

Source: Facebook Is Not A Fad