Facebook: Buy The Pullback

About: Facebook, Inc. (FB), Includes: GOOG, GOOGL, SNAP, TWTR
by: Bill Maurer

Stock decline after earnings has made valuation attractive.

Company likely to use buybacks at these levels.

Solid growth still projected for many years.

With US markets being hit over trade war fears recently, one name that has suffered a bit is social media giant Facebook (FB). Although the company doesn't have a presence in China, shares have dropped more than $30 from their recent high based on Monday's after-hours trading. With the name continuing to show impressive growth, this is a pullback that investors should look to take advantage of.

(Source: Yahoo Finance)

After two revenue misses during 2018, the company is back to its habit of beating analyst estimates. A few weeks ago, the Q2 report showed the largest second quarter revenue beat in three years, and adjusted earnings were well ahead of the street, as usual. GAAP results don't look as pretty thanks to the FTC settlement and Altera case, but those were one-time items that don't accurately portray the long-term results.

The company is expected to top $70 billion in revenues this year, and it's still growing its top line at a 20% plus clip. Based on current estimates, the name is trading at less than 19 times next year's earnings, which seems like a great deal for a name growing this fast. Competitor Twitter (TWTR), which has lower revenue growth and is barely GAAP profitable, goes for a forward P/E that's almost double that of Facebook, while Snap (SNAP) is expected to still lose money in 2020 even on a non-GAAP basis. In fact, Facebook is roughly two points cheaper on a forward P/E basis than tech giant Alphabet (GOOG) (GOOGL), which has less revenue growth and comparable EPS growth.

With the FTC settlement in the rearview mirror, combined with the decline in shares recently, it wouldn't surprise me to see Facebook to step up its share repurchase efforts. At the end of the second quarter, according to its 10-Q filing, the company had $7.35 billion on the repurchase program remaining. Even including the settlement, the company had well over $40 billion in cash on the balance sheet with plenty of financial flexibility. A little more than $10 billion in free cash flow was generated in the six-month period. As the chart below shows, this was the first time in a while that the diluted share count rose sequentially, so I think that management will look to change that.

(Source: Facebook earnings reports, seen here)

Next year, the company is expected to produce earnings per share of $9.49, which at the current share count would be a profit of more than $27 billion. Facebook is obviously the leader in the social media space, and it still grew users by 8% year-over-year despite more than two billion monthly users already. If you use a P/E of 25 for next year, which I think is reasonable given the growth profile, profitability, and strong cash generation, you get a price target of $237.25. While that might seem high based on current levels, it's just $5 above the average street target, so I'm not exactly going out on a limb. One analyst even believes the stock is worth $265.

In the end, I believe the overall market pullback provides a buying opportunity for shares of Facebook. The company really isn't exposed to China, but it's being hit like most other names out there. With strong growth continuing for years to come, the valuation seems a bit low compared to peers. The share repurchase program is likely to continue here, and I think the name will be one of the first to move higher when the market settles down.

Disclosure: I/we 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.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.