On the 28th October I published the analysis for the Investment League project which I am an administrator and a partaker. It is the educational project for learning investing among my office colleagues which allows to try investing but without taking the risk, using our virtual portfolio of shares. It gives the opportunity to understand how investing on the stock market works.
My choice to the portfolio was Facebook. On the moment of writing this analysis the price of Facebook was $145.37. Currently the price went up to $178.28 which is 22.6% higher. The price still did not achieve the calculated by me intrinsic value of $187.63. I will calculate the current value after having current earnings of the company. Facebook reports fiscal first-quarter earnings after the market closes on the 24th April.
Facebook was at that time and still is my biggest position in my real portfolio.
The below analysis was written on the 28th October 2018.
“It’s Better To Buy A Wonderful Company At A Fair Price Than A Fair Company At A Wonderful Price”
Shares of Facebook are not cheap, but the growth is incredible. The current valuation looks like a fair price.
Valuation – P/E ratio 22.47.
Let me explain why Facebook is a wonderful company.
Online advertising is around 99% of Facebook revenue. Let’s look what are the expectations.
I do not use Facebook platform too much, but I can say something about YouTube. Some time ago, I saw only some small companies advertising on YouTube. A few days ago, I saw ads from McDonald’s, Dyson or Apple. Big players are coming into online advertising – it is much easier to target the proper ad to the interested users.
Competition– online advertising
Alphabet (Google), Amazon, Apple?, Alibaba?, Tencent?
Facebook has competitive advantage as by using Facebook ads it is easier to target the demographics for the product – you can choose region, interests of people, many other metrics other advertisers have no parameters yet.
Competition – social media – Snapchat, Instagram
I will show you a few pictures below. Facebook, Instagram, Messenger and WhatsApp are all owned by Facebook.
Old Metric – Monthly Active Users
Facebook user growth slowed down – especially in the US & Canada as well as in Europe where growth is close to 0. This was the most followed metric for investors.
Source: company’s earnings slides
New Metric – Average revenue per user
It is the similar situation as was with Apple and iPhone. The number of sold iPhones was the predictor what is going to happen with the stock price. And when the number stopped growing, the sentiment changed and price of Apple stock stopped growing. But as it turned out it didn’t stop the earnings of Apple from growing. The ASP – average selling price of iPhone was still growing as well as the service revenue. And now those are the most followed metrics for Apple.
For Facebook is similar – the main metric – user growth for Facebook slowed down but the Average Revenue per User is growing annually 35-40%.
Source: company’s earnings slides
Instagram vs Snapchat – social media of younger generations
Instagram has potential to have much bigger growth than Facebook – video content is growing fast.
Do not forget that Facebook is not only Facebook and Instagram. WhatsApp, Messenger and Oculus are not earning money yet but the future of those apps and VR devices may be good bet. Also Facebook has $42.3 in cash, ready to spend on acquisition on companies.
Main risk – regulations
Regulations – very serious risk for the whole model of Facebook. Privacy issues may be a constant loud topic in media and among investors.
COO Sheryl Sandberg’s Q2 2018:
We’ll keep looking for ways to improve, and we hope these tools become standard across the industry.
She was talking about transparency and accountability. But if we broaden the context to security as a whole, a fundamental implication becomes evident: by pledging tens of billions of dollars to raise the standards of safety in social platforms and having authorities come to expect those standards, Facebook is radically upping the fixed costs required to operate a social platform.
What is the consequence of EU policies targeted at Google and Facebook? In reality it will strengthen their moats. After all, who is better equipped to navigate complex regulation than the biggest companies of all, and who needs less outside data than those that collect the most?
The final cost of policies will be paid by final user – us.
As it was with Apple – increasing cost of iPhone components – Apple is increasing iPhone prices.
Another example is the fine for Alphabet (Google) – there are plans for charging smartphone producers for preinstalling Android on their phones if they do not want to use google services.
Intrinsic value – present value of all expected future net cash flows to the company.
Growth in the past years – 40 – 50% annually. I will use very conservative metrics in my calculation.
Calculation using 20% growth in the next 5 years and then 15% growth:
Calculation using 15% growth in the next 5 years and then 10% growth:
For comparison – the current price of Facebook stock is $145.37. Price growth potential: 1st calculation: +85.6%, 2nd calculation: +29.1%.
Recent forward guidance and social concerns has created an opportunity to purchase a wide moat innovative company at a fair price.
The revenue growth will slow down from 35-40% to 25-30% which is still impressive.
Who has the time and attention of people – will earn the most in advertising revenue and the Facebook apps: Facebook, Instagram, Messenger and WhatsApp are the leaders among smartphone users.
Please note I am not a regulated financial advisor and so any help will be non-advisory. If you are unsure of the suitability of any investment you should seek professional financial advice.