Investors still don’t really understand Facebook Inc.
That was the case at the time of its overhyped and overpriced initial public offering last year, and it was evident in Thursday’s indecisive reaction to a blockbuster earnings announcement.
But stellar advertising results this year strengthen the case that Facebook has sustainable earnings growth potential and further upside despite its recently soaring share price.
“There is a real business here,” said Brian Wieser, an analyst at Pivotal Research Group in New York. “I think that’s been permanently established.”
The company’s share price has nearly doubled in the past three months, as investors become more convinced of Facebook’s staying power and its repositioning to take advantage of the shift to mobile browsing.
Advertising revenue from desktop use of Facebook has declined, but was more than offset in the third quarter by climbing mobile ad revenues, which now make up half of the company’s total advertising revenue. That figure rose to $1.8-billion (U.S.) in the quarter, an increase of 66 per cent over the previous year.
“I expected good numbers, these were great,” Mr. Wieser said. “It sets a new plateau for the business.”
Earnings of $425-million, or 17 cents a share, surpassed most analysts’ expectations. More than a dozen of them increased their price targets as memories of the IPO fiasco fade and future advertising revenues firm up.
“They clearly have the product, they have the traffic and now they have the advertising solution,” said JMP Securities analyst Ronald Josey.
But the earnings call inflamed investor concerns on two fronts. Chief financial officer David Ebersman said the number of daily users fell among younger teens, supporting reports of Facebook’s declining popularity among youth in favour of other social media like Instagram and Twitter.
Secondly, Mr. Ebersman said the company would not increase its ad frequency from a rate of one per 20 stories appearing in users’ newsfeeds.
Those ads are crucial to Facebook’s revenue stream and its valuation, but to increase the ad load too much would risk irritating Facebook faithful. “This should be factored into your expectations for next year,” Mr. Ebersman said.
Investors did so, and then some. After spiking by 15 per cent in after-hours trading Wednesday on news of the stellar quarterly financials, Facebook’s share price quickly erased those gains. The stock opened the day Thursday down 4 per cent, then shot up 10 per cent mid-day, before closing on a moderate 2.4 per cent gain.
“I think the market is gradually coming to at least have a view on the business,” Mr. Wieser said. “But you still see silly reactions to the stock.” Both of the worries that provoked the volatility were overblown, he said.
“As teens aren’t the entities spending advertising on Facebook, there is little to worry about near term,” he said in a note to investors. “So long as Facebook has a unique capability to reach more total people than any other media owner, Facebook retains an advantage in its ad sales efforts against most advertisers.”
Facebook reported 1.19 billion monthly active users as of the end of September. And the company now counts about 507 million daily active mobile users.
Plus, its ownership of Instagram, a photo-sharing service, provides Facebook with at least a partial hedge against a loss of its audience to other social media.
While concerns have been voiced over Facebook’s decision to limit its ad frequency, the company is properly trying to avoid bombarding its users with ads, Mr. Wieser said, having raised his price target to $57.
For investors who missed out on the Facebook rally since the stock bottomed out at $18 a little over one year ago, apprehension is understandable – $50 is an intimidating entry point.
While this might be a good opportunity for investors looking for a speculative bet, money managers caution that Facebook remains an expensive stock in a volatile sector.
“If you’re a Facebook shareholder, it’s a fantastic move up from the IPO,” said Barry Schwartz, vice-president of Baskin Financial Services Inc. “It’s wildly overpriced, but who cares? So are a lot of stocks.”
Trading at a multiple of about 120 times earnings, Facebook’s valuation, similar to those of companies like LinkedIn and Amazon, probably doesn’t make much sense in a balanced portfolio, he said.
“For average investors, if you want to have fun, pick one of these stocks and go wild. But this should not be part of prudent portfolio management.”
With files from Reuters