On the 28th October I published the analysis for the Investment League project of which I am the administrator and a participant. It is an educational project whose goal is to encourage my office colleagues to invest. It lets them try investing but without taking aby risks. It provides the opportunity to understand how investing on the stock market works.
My choice was Facebook. At time of writing my analysis the price of Facebook was $145.37. Currently the price is $178.28 which is 22.6% higher. The price did not achieve $187.63 which is the intrinsic value that I have calculated for the Facebook share.
Facebook was at that time and still is my biggest position in my real portfolio.
The analysis below 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”
Warren Buffett
Fair price
Shares of the Facebook company are not cheap but the growth is incredible. The current valuation looks like a fair price.
P/E ratio 22.47, forward P/E 18.02.
For comparison I present valuation ratios for the other big tech company below:
Let me explain why Facebook is a wonderful company.
Online advertising
Online advertising is around 99% of Facebook revenue.
I do not use the 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 relevant users.
Competition– online advertising
Alphabet (Google), Amazon, Apple?, Alibaba?, Tencent?
Source: statista.com
Facebook has a competitive advantage as by using Facebook ads it is easier to target the demographics for the product – you can choose region, interests of people or other metrics which 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 company.
Source: statista.com
Source: statista.com
Source: statista.com
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
The similar situation was the case for Apple and its product iPhone. The number of sold iPhones was the predictor of the behaviour of the Apple stock price. The stop in growth of the number of sold iPhones caused the change of the sentiment. The 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 it is going to be similar – the main metric – user growth for Facebook slowed down but the Average Revenue per User is growing annually at the rate of 35-40%.
Source: company’s earnings slides
Instagram vs Snapchat – social media of younger generations
Instagram has a potential for a much bigger growth than Facebook. Its video content is growing fast.
Source: statista.com
Other bets
Do not forget that the Facebook company is not only Facebook platform or Instagram. WhatsApp, Messenger and Oculus are not cash cows yet. The future of those apps and VR devices, however may become another growth factor. Facebook also has $42.3B in cash, ready to spend on acquisition on another companies.
Main risk – regulations
Regulations are 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 all.
Similar story as it was with the Apple company. The increase in the cost of iPhone components was finally paid by the users in higher cost of iPhones.
Another example could be the fine for Alphabet (Google). The company is planning to charge smartphone producers for preinstalling Android on their phones if they do not want to use Google services.
Intrinsic value
Intrinsic value is the present value of all expected future net cash flows to the company.
Growth of revenues in the past years was around 40 – 50% annually. I will use very conservative metrics in my calculation.
The calculation of PV using 20% growth in the next 5 years and then 15% growth:
The calculation of PV 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 on the basis of the 1st calculation is +85.6%, for the 2nd calculation: +29.1%.
Summary
Recent forward guidance and social concerns has created an opportunity to purchase a wide moat innovative company at a lower price.
The revenue growth will slow down from 35-40% to 25-30% which is still impressive.
The company, that 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.