There’s a market adage that stocks often make their biggest gains when the market is most fearful. Stocks, it is said, climb a wall of worry. On the flip side, when folks are most optimistic and the news seems great, stocks can fall down a slope of hope. Facebook (NASDAQ:FB) is clearly in the wall of worry phase right now.
As 2019 has gotten under way, the headlines for FB stock have gone from bad to worse. The company suffered a legal setback recently in Germany revolving around data usage. Japan is seeking to crack down on big tech companies. California’s governor is threatening to hit the big tech firms with a “data dividend” tax. That’s all in addition to the usual concerns about Facebook losing younger users and the company’s liability to future political hacking and other misuse of the firm’s data.
And, yet, despite all that, FB stock is clearly in a bullish pattern. The stock is trading back to its highest level since September, and is now more than 30% off the lows. If you were waiting for the news to turn positive, you missed the best buying opportunity for FB stock in several years. What’s changed? It starts with earnings.
Earnings Report Confounds the Bears
It’s become more or less generally accepted opinion that Facebook will start losing active users and that its margins will sink. Between Facebook being a tired platform and it having the stench of election manipulation and other scandals, people just don’t like Facebook as much as they used to.
And, yet, reading the latest earnings report, we see a different picture. The platform’s monthly active users grew to 2.3 billion, up 9% compared with the same quarter of the previous year. Given that the world’s population is roughly 7 billion people, it is impressive that Facebook is still adding users. At this size, you’d expect it to peak simply from saturation. On top of that, the media suggested that there was a big user movement to delete Facebook. Instead, growth is almost as fast as previously — the company has been running a low-double-digits user growth rate for a while now. Additionally, looking at Facebook’s whole family of products, it now has 2.7 billion users for Facebook and other services such as Instagram and Messenger monthly, and more than 2 billion daily users.
But what about profits, an FB stock bear might ask? It’s true that the company now has more than 35,000 employees. That figure soared 42% over the past year. Surely that is costing Facebook a ton? It’s true that Facebook’s operating profit margin is down from 57% last year to 46% as of this most recent quarter. But note that this figure hit 44% in Q2 and bottomed at 42% in Q3. So the 46% figure this quarter shows that revenue gains are outpacing costs once again.
At the end of the day, despite the scandals, Facebook is still a fast-growing company. Revenue growth is currently running 30% annually. That’s down from the 50% growth rate of previous years, but it is still extremely impressive for a firm of its size. 30% revenue growth, combined with rising profit margins, is more than enough to justify Facebook’s forward price-to-earnings ratio of 19. Not surprisingly, FB stock shot up almost 20 points following this earnings report.
Regulation and Taxes Ahead
We saw more negative headlines for the tech companies this week following California governor Gavin Newsom’s state of the state address. Newsom proposed a so-called data dividend that the tech companies would pay to Californians in return for using their data. Newsom said that: “California’s consumers should also be able to share in the wealth that is created from their data… [The tech companies that] make billions of dollars collecting, curating and monetizing our personal data have a duty to protect it.”
This could obviously be a problem for Facebook, Alphabet (NASDAQ:GOOGL) and other firms that rely on consumer data at the core of their business models. And you can make a credible counterargument to Newsom’s suggestion. Google and Facebook already offer their main products for free. Consumers pay for free search, email, Messenger and so on with their data rather than their wallets.
Regardless of where this California proposal goes, it’s clear more regulation is coming for the tech giants. Companies like Facebook are increasingly influencing public policy, even if by accident, in how their algorithms promote news and ads. Every story of election hacking or meddling will make politicians more eager to regulate social media. Many other developed countries are now increasingly regulating and chastising the tech giants as well; that’s probably not a coincidence.
FB Stock Verdict
With a big-tech growth company like Facebook, you’ll rarely get a perfect time to buy. Usually, these stocks look expensive, particularly when things are going well. And when a scandal hits, the media blows it out of proportion to sound like it’s going to be the death of the company or, at minimum, its stream of profits.
As I’ve suggested previously, the real upside in FB stock comes from its ability to spin-off Instagram and Whatsapp. As separate companies, they’d likely achieve much higher valuations than they do now, tied to legacy Facebook. That said, this most recent earnings report showed that even the core Facebook platform remains surprisingly resilient. With user growth still strong and profit margins heading upward, FB stock should follow it. Facebook is a solid buy under 20x forward earnings.
At the time of this writing, Ian Bezek owned FB stock. You can reach him on Twitter at @irbezek.
