Facebook’s bull rally has gone on for far too long, what is next

Facebook’s bull rally has gone on for far too long, what is next?

• Earnings and revenues show good momentum and increase
• Valuation is a lot of concern now
• Instagram is a great add-on to revenues

Facebook(FB) has made this year an impressive rally of almost 36% closing on 21st September 2016 at $129.94 per share. While this stock price increase can be attributed to strong revenues and profitability over last year, what is the future for Facebook stock?

Earnings and revenues show strong momentum

Earnings per share and total revenues show an increase during last 5 fiscal years. Free cash flow also shows an increase for all 5 last fiscal years, so Facebook has a strong financial performance and is producing a lot of cash, which is very bullish. 1 year EPS growth rate is 44.5% while next 3-5 years EPS growth rate is 69%, much higher than relevant internet industry and technology sector growth rates. So Facebook is a growth stock with a lot of momentum, but what about its valuation? Does recent rally leave plenty of stock price upside?

Valuation is a lot of concern now

While Facebook has a very good profitability trend as both its operating margin and profit margin are higher than relevant ratios for industry and sector some very important ratios, such as Price/Earnings, Price/Cash Flow, Price/Sales and Price/Book Value are much higher than all ratios of both industry and sector. Facebook has an earnings yield of 1.6% much lower than 5.1% earnings yield for S&P 500. What about the main industry peers of Facebook, Alphabet(GOOGL), LinkedIn(LNKD), Yahoo(YHOO) and Twitter(TWTR)? Facebook has a higher Price/Sales ratio than all 4 mentioned peers. Also Price/Book ratio is also higher than all 4 peers. Comparing Price/Earnings ratio Facebook has only higher ratio than Google, while both LinkedIn and Twitter have a negative ratio. As this shows a mixed trend, as a whole Facebook seems to trade at a very significant premium both compared to its industry and sector averages, and to its main industrial peers. We are concerned that while Facebook shows strong profitability, the current stock price seems to be very rich on a relative value analysis.

Instagram and WhatsApp can add more profitability to Facebook
Facebook has made several important acquisitions over last years to strengthen its dominant position in the technology sector and internet industry. Adding Instagram and WhatsApp to its business and marketing properties, these social media add-ons can provide significant revenues and profitability based on advertising platforms or charging a fee for services to their users. Social media competition is intense, but the potential of exploiting new promising sources of revenues is very large.

Conclusion

While Facebook has shown last 5 years impressive results in terms of earnings and revenues growth, and is considered a growth stock, the recent 1 year rally of 36% gains indicates that at current levels of $129.94 per share the stock is expensive on a relative value analysis. Technical analysis shows a very bullish picture as the stock both on a daily and weekly charts is above the 50 and 200 simple moving averages, which are also on a rising slope. There is a resistance around $132 per share but above that there is no significant resistance. The catalysts that can move the stock higher are mainly what sent stock higher last year, increased earnings per share and revenues. But we are concerned whether 3-5 years earnings growth of 69% is sustainable. While it is hard to ignore the strong financial performance of Facebook during last 5 years, we think at current levels the stock is not a buy. We tend towards a hold rating. Institutional ownership of shares is an impressive 72%, and this can provide support to the stock price. If Facebook fails to deliver strong earnings in the following quarters, a significant stock price correction is possible if combined with rich valuation on a relative comparison basis both to the industry, sector and the main peers. On the other hand good earnings momentum continuation could send the stock higher. We cannot rule out another stock price increase of a 10-20% from current levels sending the stock higher to 143-156 dollars per share. Any significant stock price corrections can be used as a good risk and reward investing positions to Facebook.

Legal disclaimer:
The author does not own any stocks of Facebook. Date used from sources CNBC, MarketWatch, and Morningstar.

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