I last wrote about Facebook Inc. in late July of this year, following a record quarter that sent the stock soaring to new highs. I argued that the stock price was still quite reasonable. It has been less than three months since that time, which is almost nothing in the eyes of a long-term investor like me, but I can say I feel even more optimistic about the stock today. (I added Facebook to my Strategy Lab model growth portfolio last November, and I also hold the stock personally.)
There are three main reasons for my heightened optimism. First, I have been investing a lot of time educating myself on their ad platform and I see many ways in which it is superior to Google Inc.'s platform. Second, I'm optimistic about Facebook's ability to extend advertisements beyond its own website. Third, I'm convinced Facebook can push deeper into e-commerce. Let's go through these points one at a time.
Facebook is, in my opinion, turning into a very powerful tool for small business owners to reach their target market. One of the beautiful features Facebook recently enhanced is called the "Lookalike Audience." As they describe it, "Lookalike Audiences let advertisers find people who have similar characteristics to their existing audiences among people who are on Facebook."
Small business owners are not the only ones who can advertise on Facebook, but they are a huge growth opportunity that Facebook is capitalizing on. A couple of years ago Google was pretty much the only game in town. Facebook is not only another option, but it genuinely provides advertising solutions that Google cannot offer. It's nice to have choice.
When I first considered investing in Facebook, I didn't like the way the ad solutions were restricted to Facebook's own website. Later, this included their mobile apps. This is now changing. Just like Google, Facebook is known to be building tools to let advertisers display ads outside of Facebook.com. Website owners will be able to ask Facebook to supply ad inventory to their sites and, presumably, collect a portion of the revenue generated from the advertisers. Because people tend to stay logged in to Facebook at all times, this type of advertising could trigger a lot of useful data collection. Facebook should be able to further improve its ability to target ads to interested audiences.
Finally, I expect to see Facebook dive deeper into e-commerce. Advertisers may benefit from being able to put "buy" buttons directly on their ads or on their websites, using Facebook to collect the revenue instead of PayPal or other alternatives. Facebook has partnered with payment processing startup Stripe to beta test this concept over the past few months. Given the huge size of Facebook's audience and growing set of sophisticated advertising tools that vendors have access to, I can see how integrating e-commerce could be useful. Facebook may be able to help advertisers sell more while collecting fees from the service.
Based on the most recent quarter's numbers, Facebook is on track to generate annual profit of about $1.68 (U.S.) per share which means the stock trades at about 46 times earnings. Looking at this in the context of last quarter's impressive 121 per cent year-over-year earnings growth rate is enough to make me think the stock is very reasonably priced. But when I also consider the potential for rapid expansion of advertising outside of Facebook and the potential for an entry into e-commerce, I think the upside opportunity over the next decade is incredible.