Investors began to "Like" shares of Facebook, Inc. (NASDAQ:FB), which touched all-time high of $45.62. They surged 89 percent in the past three months and 17 percent in the past one month.
Over the last 12 months, Facebook shares have gained 115 percent versus 16 percent for the S&P 500. Average volume of shares traded over the last three months came in at 58.59 million while today's volume was hovering around 48 million.
The rally in FB shares began when the social networking giant reported solid second quarter results in late July, when the shares were trading at around $25. Since the last quarterly report, shares have climbed 70 percent.
At the current valuation, FB shares trade 48 times and 4.7 times its forward earnings and sales respectively. Analysts expect Facebook earnings to grow 50 percent this quarter and 34 percent in 2013, with sales seen improving at a similar rate. For 2014, the Street forecasts the company's earnings to increase 34 percent on sales growth of 31 percent.
Now that Facebook trading at an all-time high, the question for investors is whether the company could justify the recent rally.
The jury is still out, while Facebook has the firepower to reward investors. Facebook has a user base in excess of 1.15 billion, with mobile monthly active users (MAU) at 819 million (71 percent). Mobile-only monthly active MAUs for the second quarter were 219 million, up from 102 million a year ago.
Facebook proved that it is monetizing its mobile user base as its mobile revenues of $656 million accounted for 41 percent of ad revenues. North America price per ad jumped 40 percent from last year, indicating that demand, pricing and advertiser returns all seem to be improving at the same time.
Growing mobile ad revenue from nil at the time of the IPO to more than $650 million in four quarters is no mean feat. The fact that mobile is driving Facebook revenue growth is a distinct positive considering the secular shift to mobile usage that we are seeing in the industry.
The advertiser adoption of new product launches in both the recent past such as FBX in Newsfeed and mobile app installs also underscores Facebook's revenue potential.
Facebook remains under-monetized user base relative to peers given the time spent on the platform. Though Facebook currently generates more revenue per user than Yahoo, Inc. (NASDAQ:YHOO) or AOL, Inc. (NYSE:AOL), it is still significantly under-monetized versus Google, Inc. (NASDAQ:GOOG) its largest advertising peer.
Facebook ads exhibit strong pricing power. On the second quarter earnings call, CEO Mark Zuckerberg disclosed that on-average, ads comprise about 5 percent of the stories in a user's Newsfeed, up from 0 percent a year ago.
The next form of monetization could come in the form of video ads in Newsfeed. Newsfeed (both desktop but more importantly mobile) is the biggest driver of future revenue growth, so judging the stage of adoption for newsfeed monetization is critical to the overall investment thesis.
Facebook plans to prioritize expanding the number of marketers on the platform rather than simply increasing the number of impressions. This approach would act as a key catalyst in boosting ad momentum both in terms of growing revenue and in terms of preserving engagement.
Looking ahead, Facebook should see increased contribution from video advertising as Facebook is expected to begin selling Newsfeed video ads in the second half of 2013.
"Some of our early checks have indicated that Facebook might be able to generate approx. $2-4mm per day from video ad products (in North America alone) in 2014," UBS analyst Eric Sheridan said in a client note.
Furthermore, a recent study released by Nielsen compared Facebook to the four top TV networks and found that Facebook's reach exceeds that of the TV networks during daytime for most age groups (particularly in the 18-35 range). These findings provide a compelling business case for TV advertisers to adopt Facebook video ads going forward - both to extend their reach and to reinforce their message with consumers.
Meanwhile, Facebook's FBX may take share from email retargeting following Gmail Inbox changes. Google rolled out a new Gmail Inbox that would automatically categorize a user's mail into separate tabs for social notifications, deals/promotions, etc.
In addition, the company is yet to unveil its key weapon - ads on Instagram. Facebook recently introduced video on Instagram. The introduction of video will likely make the service more compelling, leading to greater user engagement and also opening the door to lucrative video advertising.
Facebook does not currently monetize Instagram, but it could be a solid long term contributor. Video is clearly a large opportunity on the Internet, with YouTube, which is expected to generate up to $5 billion in revenue this year, as the prime example.
With more weapons in its armory, Facebook looks poised to leverage its 1 billion plus user base while it should see to that it drives more business from desktop to mobiles.
If all goes well, Facebook shares could even touch $50. However, a slight failure could cost shave away billions from market capitalization, which currently stands at about $110 billion. So, investors should watch the results of next two quarters to decide whether Facebook manages to sustain the momentum in its business
Disclosure: I am short FB.
Additional disclosure: This article was posted at iStockAnalyst.com.