Social media, and many "new" tech names more broadly, are arguably value investors' most hated stocks. Many trade based on revenue growth, user growth, and total addressable market, rather than on earnings, which was a recipe for disaster back in 2000. In my opinion, the concerns about valuations in many names, like Twitter (NYSE:TWTR), Zillow (NASDAQ:Z), and FireEye (NASDAQ:FEYE), makes sense because they have no proven ability to generate consistently strong profits despite significant popularity. To me, the only social stock worth owning is Facebook (NASDAQ:FB) because it is generating significant profits, has figured out mobile, and CEO Mark Zuckerberg is consistently acquiring potential competitors to fortify FB's moat. The company's strong quarterly results only affirms my optimism.
In the company's second quarter, it earned $0.42 on revenue of $2.9 billion compared to expectations of $0.32 on revenue of $2.8 billion (financial and operating data available here). Revenue jumped a fantastic 61% while earnings were up over 100% year over year. Facebook is in the process of swiftly monetizing its massive user base, which is leading to truly tremendous growth. Even with slowing user growth, continued monetization improvements, which appear to be in the pipeline, should power dramatic sales and earnings growth. The company also is getting benefits of scale as operating margins improved from 48% to 59%. For all of the discussion of acquisitions, advertising is still the core of Facebook's business, accounting for 92% of revenue, and it grew an even faster 67%.
Importantly, user engagement is still strong. Investors need to watch these measures for signs of fatigue, which could precipitate a drop in advertising revenue, but right now, engagement is not a problem. Daily active users were up 19% to 829 million while mobile daily activity users were up 39% to 654 million. 78.9% of daily active users are now mobile users, and Facebook's mobile dominance gives it the scale to aggressively expand into messaging, which is a reason it acquired WhatsApp. There were similar results on the monthly active users with mobile up 31% and overall growth of 14%. Importantly, the growth in daily users was faster than the growth in monthly users, which implies Facebook is getting users to check in on the social network more frequently. Engagement is strong, and Facebook is a truly mobile-oriented company.
Fortunately for shareholders, Facebook is monetizing this increased mobile usage. Mobile advertising accounted for 62% of advertising revenue, compared to 41% a year ago. Mobile revenue jumped an astounding 156% year over year. While many companies like Yahoo (NASDAQ:YHOO) have struggled to deal with increasing mobile usage, Facebook has tailored news feed ads exclusively for mobile, and it has led to fantastic results. Increasing mobile usage is a positive for Facebook's business, separating it from the vast majority of internet companies.
Facebook has an unparalleled amount of data on its users, allowing it to better tailor ads. Between this and mobile ads that actually work, Facebook has been able to dramatically increase the price of its ads with prices more than doubling, more than fully offsetting the decline in impressions. Facebook is also exploring ancillary forms of revenue like a "buy button," which would help to provide incremental growth. These initiatives sent cap-ex spending to $469 million, but free cash flow was still a robust $872 million. At the end of the quarter, Facebook had $14 billion in cash.
Overall, Facebook reported fantastic results. Engagement was strong, which translated to significantly higher revenue. Ad revenue also benefited from Facebook's strong mobile presence and the richness of its user data that allows for better targeting. Facebook is one of the few internet firms that is growing rapidly, is solidly profitable, and generates free cash flow. For the full year, FB should earn $1.55-$1.60, which will be up about 90% year over year. Looking into 2015, Facebook should be able to earn about $2.00-$2.10, a growth rate of about 30%. With its growth rate, Facebook can be bought up to 40x 2015 earnings. If we add back in its cash position, Facebook should be able to reach $90 within the next twelve months. FB is the most compelling value in social media because its forward valuation is fair and it is actually profitable. Investors should stay long.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.