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Facebook: Look at the margins, not sales or earnings

Eric Thayer/Reuters

As Facebook shares plummet, market cynicism is focused on declining profit margins.

In quarterly earnings announced Thursday, its sales and profit exceeded analyst expectations. Yet the company continues to experience difficulty converting new users into higher revenues.

Facebook's operating profit margins declined 10 per cent for the quarter to 43 per cent. Average revenue per user, among the most important indicators of future profitability for technology stocks, disappointed analysts at 12.7 per cent for North America.

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"Ad revenue growth was driven by 31 per cent y/y growth in [Monthly Active Users]" writes Credit Suisse analyst Spencer Wang, "and 2 per cent y/y decrease in Advertising per MAU".

CEO Mark Zuckerberg declined to address concerns regarding future profit growth during the corporate conference call, stating "I don't really have any plans that I'm going to share with you today about our product roadmap".

Facebook's aggregate growth remains healthy despite profit concerns. Year over year revenue growth was 32 per cent and Mr. Wang believes that current stock valuations represent longer-term value.

"FB is now trading in-line with our valuation for just the core business", he writes, and this implies "little [value] is being ascribed to new revenue opportunities".

Mr. Wang is hesitant about the short-term outlook, noting that the company's shift to mobile revenue sources is in the early stages. Management reported success with recent mobile advertising strategies, but also noted that the initiative will proceed slowly in order to avoid offending users.

Facebook's results continued a difficult week for the technology sector which also saw disappointing profits from Apple Inc. and Amazon.com. Zynga, an online gaming company with close associations to Facebook, yesterday fell almost 40 per cent after reporting weak growth.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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