Facebook (FB) is worth $35 per share, and the stock price will reflect that by midyear.
In one of the most talked-about stock stories of the past 20 years, FB has taken us investors on a wild ride during its first nine and a half months of public trading. First it was the outlandish valuation at the time of the IPO. Then it was the Nasdaq computer glitches on the first day of trading, followed by a sizable one-day spike and a precipitous downfall. The shorts were reveling in success on September 4, 2012, when the stock closed at $17.73, a 61% discount to the highs the stock reached just four months before. But bulls took charge and shares rallied handsomely since reaching those lows - after touching highs close to $33 earlier this year, the stock is currently trading at $27.77, a 57% premium to the September lows. Even after the rally, though, FB is still trading at a 27% discount to the IPO price.
Will shares of FB ever get back to the IPO level? And if so, what's going to drive the rally?
The answer is absolutely, and here's why:
Growth in User Engagement and Top Line Revenue
One of the core, fundamental tenets of business is growth. Growth drives increased valuation, it drives hiring and new R&D, and it drives demand for acceleration in new product line launches. Driving growth drives numbers - both top and bottom line - and is essential for any company to maintain its position as an industry leader.
FB continues to grow at an accelerating rate, dominating the world of social connectivity. User engagement is soaring:
- Monthly active users (MAUs) were 1.06 billion as of December 31, 2012, an increase of 25% year-over-year
- Daily active users (DAUs) were 618 million on average for December 2012, an increase of 28% year-over-year
- Mobile MAUs were 680 million as of December 31, 2012, an increase of 57% year-over-year
- Mobile DAUs exceeded web DAUs for the first time in the fourth quarter of 2012
In addition to the continued growth in user engagement, FB has continued to show improved levels of user monetization. After all: FB can have billions of users, but if it is not able to monetize those users, the business will fail.
Revenue has grown sharply over the past year, and that revenue growth is poised to accelerate into the next four years. FY 2012 revenues were $5.09 billion up from $3.71 billion in FY 2011. That's an increase of 37.2%, year over year. Analysts predict revenues in FY 2013 of $6.66 billion and in FY 2014 of $8.44 billion, increases of 30.8% and 26.7%, respectively over the previous year's performance.
Growth in Bottom Line Profitability
Growth in top line revenues is an excellent metric to determine the viability for investment in a company. However, the ultimate catalyst for an increased stock price is earnings growth. Despite the terrific rise in revenues between 2011 and 2012 (37.2%), FB only saw earnings growth of 6% from $.50 per share in 2011 to $.53 per share in 2012.
The company is poised for sustained earnings growth through the next three years.
As noted in the graphic above, analysts forecast annual earnings growth of 7.5%, 38.6%, 32.9% and 43.8% for the next four years. This accelerating bottom line growth can be attributed to a few factors:
- Continued growth in mobile advertising revenue - mobile advertising revenue was 23% of overall revenues in Q4 2012, up from 14% in Q3 2012. The mobile market is growing significantly faster than any other medium on which FB is browsed. Increased focus here will drive bottom line growth into the future.
- Continued growth in overall user engagement - as noted above, FB is adding more active users faster than ever before
- Continued innovation and new product launches - Graph Search, the newest FB product, is a game changer and just made the company locally-relevant; additionally, Graph Search adds Google (GOOG)-like search capabilities to the social network, further increasing the company's insight into its user base, thus further increasing the premiums it can charge for hyper-targeted advertising
From a fundamental valuation perspective, shares of FB are not as expensive as they're cracked up to be. The fall after Q4 earnings - the stock is trading at a 14.5% discount to its trading level before the announcement - was attributed mostly to the fact that mobile advertising accounted for only 23% of overall revenues. The street was looking for 25%. As noted above, though, the 23% performance is a 64% increase from the previous quarter. Since that earnings release, though, the street has become quite sour on the stock. The new darling of the social media space seems to have become LinkedIn (LNKD) because of its ability to monetize users. The same analysts touting LNKD are saying that FB is too expensive. They're sadly mistaken.
FB is trading at a Forward P/E of 48.3 and LNKD is trading at a Forward P/E of 131.3. Well, the answer must be that the price is accounting for future growth beyond 2013, right? Wrong. Look at the chart below, which documents the analyst's forecasts for LNKD's earnings growth through 2016.
The growth looks impressive - that's nearly 50% growth per year for the next four years. There's only one problem. Even with the tremendous growth, if you're to compare the price of LNKD shares today to its 2016 earnings, you'll get a P/E Ratio of 38.34. If you do the same with FB, you'll get a P/E Ratio of 18.22. Accounting for the next four years of growth, which stock seems cheap now?
I'm not discounting the great business that LNKD is doing. In fact, I'm long-term bullish on that stock as well. The current stock price levels as compared with future growth estimates need to be put in perspective, however, to determine which stock is cheaper with a forward-looking eye.
FB seems to be just about executing on all cylinders. That shouldn't be happening yet. The company is still a baby - it has been publicly traded for less than a year. That wouldn't ordinarily matter, given the fact that the company is nearly nine years old. However, CEO and Founder Mark Zuckerberg has made it clearly known that his interest is not in growing the company as an investment, but instead as a product. Only in the past few years has he begun to put the team around him that will drive the financial success of the company (Sheryl Sandberg, among others), to drive valuation in preparation for the IPO. Investors often look for a divergence in indicators to signal buy and sell points in a stock. The divergence here is that the company has the benefit of its first nine-year-old gray hair while the financials of the company are still in infancy. Once those financials catch up - and they will with the team that Zuck has built around him - this stock will soar above its IPO level.
For now, the stock is worth $35, and with growing user engagement, increase in mobile advertising as percentage of business, and continued innovation in the product pipeline, we'll see that price much sooner than later.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FB over the next 72 hours.