Facebook Still A Good Buy Despite Lofty Valuation

| About: Facebook (FB)

Facebook (NASDAQ:FB) has been making headlines of late, but this time for all the right reasons. For a stock that many analysts loved to hate and that was getting bashed left, right and center barely a year ago, the social media giant has made a wunderkind recovery and is currently trading at $39.98 (and steadily rising as I write this article), above its $38 IPO issue price. That price has already broken its 52-week high of $39.32. Facebook builds tools that enable its users to connect, discover, share and communicate while also enabling developers to build social apps or integrate their websites with FB. Advertisers and marketers can use Facebook products to engage with its users. Facebook's mobile advertising is steadily improving and video ads have begun their roll-out.

What we can learn from Facebook's stock movement

When you analyze Facebook's stock movement, the following pertinent facts appear:

  • The stock could possible stall or reverse between the current trading level and the $40 price level. This represents a 50% return YTD.
  • Average Direction Index suggests that the current uptrend is close to reaching its maturity stage.
  • Call buying on Facebook has been highly aggressive during the past 12 days with a call: put ratio of 3:1.This of course indicates extreme optimism about the stock.
  • Based on FB's daily volume, the number of ''days to recover'' required to cover all short positions, assuming all traded puts went to cover the short position, is only half a day. This is quite low compared to its peers' stocks. Most shots, apparently, have exited the building.

In short, the market is overly optimistic about Facebook - 26 out of 30 analysts polled have rated the stock as a ''buy.''

We can also use other under-the-radar metrics to see what they are telling us about the stock. Hedge funds and insider trading activity are some of the most reliable of these. Heading into the third quarter, most hedge funds that had positions in the stock were bullish and a sizable amount even upped their stakes significantly.

Insider shorting activity

Legal insider trading is particularly useful as a guide of where a stock is headed to if the transactions have happened in the past six months. Facebook, Inc. has recorded zero unique insider purchases but nine insider sales. Check out the chart below that compares the stock with those of close peers Google, Inc. (NASDAQ:GOOG), Yandex NV (NASDAQ:YNDX), LinkedIn Corp (LNKD) and Baidu.com, Inc. (NASDAQ:BIDU).

Company Name

# of Hedge Funds

# of Insiders Buying

# of Insiders Selling

Yandex NV




LinkedIn Corp








Google, Inc.








These companies are internet information providers and their market caps are comparable to Facebook's.

Facebook has been experiencing dropping sentiment from the upper-tier hedge fund managers, who are standing pat, and significant shorting activity from its insiders. This contrasts sharply to the overall bullish sentiment from middle-tier hedge fund managers.

Facebook valuation

There has been a lot of hullabaloo by investors with both short and long-term positions in Facebook about the valuation of its stock. The stock is no doubt expensive, trading at 180.33x TTM earnings and a much fairer 41.95 x forward one-year earnings P/E. The valuation is quite lofty even for a growth stock. The expected PEG ratio for the coming years is a very fair 1.84. This means that for investors willing to hold onto their Facebook shares for a longer term, the expected growth profile of the company will eventually balance out its expensive share price and catch up with the expensive valuation. But P/E and PEG ratios are mere guidelines and smart investors know that it is quite possible to make good money trading with expensively-valued stocks. Let's look at some catalysts that might justify that kind of valuation:

  1. Ad revenues expected to rise significantly

A recent survey carried out on 3 leading Facebook PMDs (Preferred Marketing Developers) revealed that they are optimistic that despite the company's flat revenues in the third quarter, its ad revenues are poised to increase significantly in the coming quarters, riding on the company's positive mobile outlook and strong positioning. Other important ad tenets such as adoption of the platform by direct response advertisers and marketers, rising adoption by international marketers, and increased traction with CPG/Auto advertisers will all help drive ad revenues for the social networking giant.

2. Growing mobile ad revenue

Analysts expect a 12% Q-o-Q growth in mobile ad revenues for Facebook, Inc. The company is expected to record a 61% growth in ad revenues this year, with the strong growth helping to offset the 5% Q-o-Q decline being experienced in the PC industry. Pricing is expected to stabilize. PDMs expect a strong growth momentum on mobile ads fuelled by mobile app installations as well as higher click-through rates. The surge in direct response advertising will also help Facebook build a stronger ad platform in the coming quarters.

3. Video ads with Instagram growth

The leading Facebook PMDs are also optimistic that video ads and Instagram will drive new growth for Facebook in the future, although they were not too sure about the timeline. CPM for video ads could be $20-$40 per 1,000 impressions. That's much higher than the mid-single digit levels typical of news feeds ads. Instagram currently has a 130 million-user base.

4. Europe and Asian markets to grow

The Middle Eastern and South East Asian markets are showing strong growth potential due to increased advertising interest. The strong growth of smartphone users in developing markets is another key growth driver for Facebook. Ad revenues per user in Europe are currently just half of the levels in the US while Asian rates come in at just a quarter of that. This represents a significant upside potential for Facebook.

5. Stock on the mend

Many analysts believe that Facebook's stock is on the mend and the bullish trend is expected to continue for quite some time. Although some analysts believe that the stock can cross the $50 mark this year, I'm more willing to go by the guidelines of analysts such as UBS AG who have raised their FB price target from $36 to $45 and JP Morgan analysts who have raised it from $38 to $45.

One of the biggest reasons why Facebook still remains a hot stock is the fact that the social media company boasts a user base of close to a billion people. This is potentially an enormous market. The firm booked $1.6 billion in ad revenues last year with total revenues coming in at $1.81 billion. The advertising platform is therefore critically important for Facebook. The strong overall growth in this platform is definitely something to write home about. Facebook might not be at par with Google in terms of growth or Apple (NASDAQ:AAPL) in terms of FCF, but the stock is well worth having.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.