Is Facebook Too Cheap to Ignore?

Introduction

Facebook’s Earnings were released today. The update at end of this blog post covers the key takeaways.

It’s been quite a couple of months for Meta Platforms (ticker FB), commonly known as Facebook, which is the name I will use for the remainder of this article.

To be more specific, it has been all downhill for Facebook since their earnings announcement on February 2nd, 2022. On that day the stock closed at $323. Their earnings announcement was after hours. It would be an understatement to say it wasn’t well received. The stock opened trading the next morning at around $244, down a whopping 24%, and closed even lower at $237.76, down over 26%. That is a seriously bad day for a stock as large and widely held as Facebook.

Things continued to go downhill as the month progressed, with Facebook getting as low as $185.82 on March 14th. As of this writing, which is the closing price on April 21st, the stock remains near its 52 week low at around $188. That’s down another $56 (23%) from the initial impact of the earnings announcement hit. It is also around $196, or over 50% off its all-time high of $384.33 set on September 1st, 2021.

Normally when I analyze a stock, I look at both its fundamentals and technicals. However, in the case of Facebook, there is no reason to spend a lot of time dwelling on the technicals. They’re beyond awful. Everyone hates the stock. So if you are a short term trader, Facebook is probably not the best place to make a quick buck on the upside unless you are really good at dead cat bounces.

But what for the long-term value investor? Here is where it gets more interesting. In this blog I plan to use the power of Stock Rover’s research capabilities to try to shed some light on that question.

Chart of FB (in blue) vs industry (in green) and S&P 500 (in red) since February 1st 2022.

Stock Rover Price Chart with Benchmarks

How Cheap is Facebook Historically?

The short answer is Facebook is by far the cheapest it has ever been. The saying is one picture is worth a thousand words. If we look at look at Facebook’s P/E chart last 5 years we can see how true this is.

Facebook’s P/E over the last 5 years has been as high as 45. It has generally been between 22 and 42 for the last few years, right up to the infamous earnings announcement of February 2nd. Since then the range has been more like 13 to 17. It currently sits at 13.7.

A Price to Earnings ratio of under 15 for a mega cap growth company is extraordinarily cheap. By way of contrast, two other large Mega Cap growth companies, Google (GOOGL) and Microsoft (MSFT) currently trade at P/E’s of around 22 and 30 respectively. Amazon (AMZN) is even higher at 46.

Stock Rover Fundamental Chart

Below is another technical chart from Stock Rover called Price vs. Valuation. It is quite a powerful chart and can be found in our charting facility from the Valuation drop down menu above the charts.

Stock Rover Price vs. Fundamental Valuation Chart

This chart shows the earnings over time as the green background, the price in the foreground as a blue line, and the 150-day simple moving average of the price as a red line. The 150-day SMA shows the price in a “smoothed out” fashion.

The way to read this chart is by the height of the red line vs. the height of the green backdrop. The lower the red line sinks vs. the green, the cheaper the stock. We can see that earnings growth has been substantial over most of 5-year period and has flattened recently. However, the price line has headed south and the gap between earnings and price has never been bigger.

A couple of notes on the results. The lack of profitability in the first two quarters of 2019 were due to an accounting adjustment, specifically Facebook taking a $3.0 billion charge due to a Federal Trade Commission inquiry in the first quarter of 2019 and then another $2.0 billion for the same reason in the second quarter of 2019.

So clearly the stock is extremely cheap vs. its historical valuation. But taken by itself that is not all that surprising. When growth companies get bigger and their earnings growth slows, valuations do tend to compress. What is surprising however, is the both speed and the degree of the valuation compression.

How Cheap is Facebook vs. Peers?

So Facebook seems to be quite cheap vs. itself. What about vs. its peers?

Of course, first we need to back up and start by asking who are its peers? Because Facebook is such a behemoth, it would make sense to start by looking for other behemoths that are similar in classification – large cap growth in the tech world.

When we do that, we find other behemoths like Apple, Google, Microsoft and Amazon. While there may be some overlap, the actual business of these companies differs. We can also look at direct competitors, like Twitter and Pinterest, but they are much smaller than Facebook. Let’s include both types of peers.

I have put together a large cap tech watchlist of stocks called Facebook and Peers and it contains the following companies.

• Adobe (ADBE)
• Alphabet (GOOGL)
• Amazon.com (AMZN)
• Apple (AAPL)
• Facebook (FB)
• Microsoft (MSFT)
• Nvidia (NVDA)
• Pinterest (PINS)
• Twitter (TWTR)

As previously mentioned, business-wise Pinterest and Twitter are most similar to Facebook. The others are large cap growth technology companies that people tend to think about when they are thinking about Facebook as an investment candidate. They are competitors for investment capital.

Using the Table feature of Stock Rover, the following screenshots show some key metrics from the Valuation view, sorted by Price to Earnings ratio. Note that Twitter is on the top because it does not have positive earnings.

We can see that Facebook’s P/E of 13.7 is more than a 40% discount relative to the next closest company, Google. Apple and Microsoft sport P/E’s approximately twice Facebook’s. And Pinterest, which is roughly in the same line of work, sports a P/E of over 3x the P/E of Facebook.

Stock Rover Table – Valuation View

We should also look at a few other key valuation metrics, such as Price to Earnings, adjusted for cash and debt. Using that metric, Facebook is still by far the cheapest.

How about EV / EBIDTA (Enterprise Value divided by Earnings Before Interest, Depreciation, Taxes and Amortization), a favorite valuation metric of analysts and professional investors? Ditto: Facebook is by far the cheapest.

How about Forward P/E? Ditto.

Lots of investors like to look at Free Cash Flow rather than earnings as a true indicator of corporate profitability. How does Facebook look here? Using Enterprise Value / Free Cash Flow, again we can see that Facebook is easily the cheapest company in our little peers universe.

Some people like to use Price to Sales rather than Price to Earnings as a metric. Here Facebook is in second place, only beaten by the web retailer (read low margins) Amazon.

The only metric where Facebook is not more attractive valuation-wise relative to other other companies, specifically Twitter, Google and Nvidia, is PEG Forward. PEG Forward is calculated by dividing the forward Price/Earnings Ratio for the next 12 months by the estimated Earnings Per Share (EPS) growth for the next 5 years. This means that the market is expecting less earnings growth from Facebook than from these other three companies. This is a perfect segue to our next section – growth.

How Fast is Facebook Growing vs. Peers?

So Facebook is quite cheap on Valuation. Maybe there is a good reason. Perhaps there is a growth problem. Let’s take a look.

We are going to look at both revenue growth and earnings growth. We start by using Stock Rover’s Growth View in the Table.

Here we begin to get an inkling of the reasons behind Facebook’s lower valuation numbers vs its peers. The story is a bit complicated. Let’s dig in.

Stock Rover Table – Growth View

Here I have sorted sales growth by the last four quarters relative to the four quarters one year prior. I want to get a sense of how fast the various companies are growing their businesses.

There are some extraordinary growers in this group. Google is growing sales by 31%. Given its size, this is incredible. Even more incredible is Nvidia growing at 61%. Still with that, Facebook is also showing very strong revenue growth of 25% and it has sustained that pace over the last three years, a rate that considerably eclipses Amazon, Microsoft, Apple and Adobe – all strong growers themselves. That doesn’t feel like a company that should be sporting a P/E in the thirteens. What is going on?

Well, if we look at EPQ Quarter over Quarter change, which is the change in earnings from the most recent quarter relative to the same quarter one year ago, we get a whiff of a problem. Facebook actually declined in profitability by 5.4%. How do they do that with a corresponding 20% Q over Q sales gain? We will need to investigate that.

So a couple of other things. First, note the only other companies to decline in quarter over quarter profitability were Twitter and Pinterest, both social media companies. All the non-social media companies increased their Q over Q earnings. This would be indicative of problems in the space, like an emergent new competitor. Tik Tok fits that bill (more on Tik Tok later). You can clearly see the effects of Tik Tok on the profitability of the other companies in the space. Note that even with Tik Tok, all the companies are still growing sales rapidly. However, they are spending a lot more money to defend their turf.

This brings us to expenses. All of the social media companies are spending heavily for revenue growth. However the steep expense ramp has really eaten into their earnings growth. Each of the companies would say this is a good thing, that they are investing for their future. And maybe it is, but that remains to be seen. But there is no doubt that the earnings train is creeping in reverse while the sales train drives forward.

This definitely sheds some light on the compressed multiple for Facebook. But still, a P/E under 15? There must be something else going on.

More Stuff to Consider

Let’s start looking for additional problem areas using Stock Rover’s Research Report facility, specifically the Warnings section. We want to see if there is something else we should be thinking about. The following screenshot shows the current warnings posted by Stock Rover for Facebook.

Stock Rover Research Report – Warnings Section

The first two are technical warnings, and they are telling us what we already know. The price performance of Facebook is horrible.

The third warning, while not great, is not surprising – High Stock Based Compensation. This is an issue for every high-tech company, as it is one of the ways they spend to compete for talent. For Facebook, it is even more exacerbated because the reputation of the company has been dinged quite a bit relative to other tech companies. Even higher stock-based compensation is likely needed to attract and retain good employees relative to its peers, who have made less negative news. Still, this doesn’t seem worthy of anything more than couple of integers off of the P/E.

One other thing I want to consider is if Facebook has any seasonality in its stock price performance, in case I actually decide to buy the thing. Seasonality can help with timing. From Stock Rover’s Research Report we see the following.

Stock Rover Research Report – Seasonality Section

The good news is if we decide that Facebook is indeed too cheap to ignore, we are seasonally past the two worst months of purchase and are in a good period to consider buying.

What do the Analysts Think?

Well, we have concluded that by any valuation measure, Facebook is extremely cheap, which in turn means the market has grave doubts about Facebook’s future prospects and earning power relative to is past performance. And we got a whiff of an earnings issue when we examined growth. Let’s see what the analysts say.

Facebook is a widely followed company with lots of analyst coverage. The following screenshot shows Facebook’s analyst ratings taken from the Stock Rover Insight panel, Analyst tab.

Stock Rover Insight Panel – Analysts Tab

Here we can see the Analysts like but don’t love Facebook. It has an overall Buy rating, which is pretty standard for Analysts as they tend to be an optimistic lot. They tend to be slow to revise their estimates and target prices downwards when a business starts going south. In other words, they are a lagging indicator.

With that said, we can see a divergence. The average Analyst Target price which is generally 12 months from now is $320, which is way above its current price of $188. Normally that would make Facebook a very strong buy. But the analysts are also getting more negative on the stock vs. where they were 90 days ago, which was before the big price drop. 5 of 22 Analysts have moved off Strong Buy, even though the stock is far cheaper than it was 90 days ago. So that is not good. The Analysts seem to be buying into the “not as a great a future as we thought” narrative.

In the following screenshot, we can see how the Analysts have adjusted Facebook’s future earnings estimates from 3 months ago, before the big price drop.

Stock Rover Insight Panel – Analysts Tab

We can see big revisions downward, to both the 2022 and 2023 expected earnings. However, the expected earnings drop of 13% to 14% has translated to a price drop of well over 40%. An overreaction? Perhaps. Let’s keep going.

What Are Facebook’s Future Prospects?

Last, but definitely not least, let’s try to shed some light on Facebook’s future prospects, using the Stock Rover news feature.

I have been reading a number of stories about Facebook, specifically the concerns investors have regarding Facebook’s future. The information has been very interesting and has shed a lot of light on the valuation conundrum. It turns out, there are several important headwinds that Facebook is dealing with. Here is a brief list of the biggest issues facing the company.

Apple

Apple has implemented something called Advertising Tracking Transparency policy (ATT). This means that when you first launch an iOS app, it pops up a simple dialogue box that asks you if you want to allow the app to track your activity across other companies’ apps and websites. Unsurprisingly, a large proportion of users have said no thank you to this.

Facebook expects that this little feature of iOS will take around $10 billion (9%) off its top line revenue in 2022. Ouch!

Tik Tok

Tik Tok has come from nowhere to its current state of generating around 4 or 5 billion dollars in revenue in the last year. Furthermore, their revenue run rate is increasing dramatically. Their last three years were:

• 2019   $350 million
• 2020   $1.9 billion
• 2021   $4.6 billion

Tik Tok is clearly a major competitive threat to Facebook and its vaunted growth.

Meta

Facebook is pouring, and I mean pouring, resources into artificial intelligence and machine learning under the label of Meta. They are hoping to strike gold with another major growth opportunity in virtual reality. They are also are trying to find ways to improve the return on investment for Facebook advertisers.

The spend rate for this massive program is currently in the neighborhood of $10 billion a year. And it is increasing. It also expects no revenue benefit from this program until later in the decade.

$10 billion a year represents over 20% of their total expense spend, or 20% less that goes to their bottom line. This translates to around $3.60 a share in earnings. Using the current multiple of around 14, this equates to over $50 of share price down the drain, from an investor point of view. This is because many investors feel this money is ill advised spend and has no chance of recovering anywhere near the costs of the program.

Governmental Inquiries

I haven’t touched the Federal Trade Commission or other governmental inquiries into Facebook occurring in the US and around the world because this has been going on for a while now. But given Facebook’s dominance, it is of increasing relevance and could be another large black cloud on the Facebook horizon. Investors hate uncertainty and the outcome of potential governmental action is a very uncertain thing indeed.

So What Does it All Mean?

So how do we make sense of all this?

In short, the stock is cheap, stupid cheap by almost all measures. On the other hand, the market isn’t stupid, far from it. Facebook’s business prospects are facing a whole host of major headwinds, some external, some self-inflicted. Each by itself would be a significant drag on the stock. But with all of them together, you get a multiple less than 15 on a company that is growing revenues by 25% a year.

So what you do?

In my opinion it comes down to how much faith you have in Facebook’s management. And given that the central control of the company is essentially in the hands of one individual, that really means how much faith do you have in Mark Zuckerberg? He’s has a long and great track record for growing the company, but in this new latest environment, he also may be a little too far over his skis.

If you think he and Facebook can mitigate these headwinds to some degree and outperform the currently dismally low expectations attached to company, then the stock should eventually recover and perform well over the long term. Remember he and the management team are highly incentivized to get the stock price higher and they have lots of levers to do just that.

On the other hand if you think that this is just a beginning of an endless array of issues that the company will face in the future, and that the forecast for Facebook will always be cloudy, then you can expect a long slow slog for the company and its lagging stock price. This conclusion would mean that Facebook should be avoided as there are better, cleaner places to invest your long-term capital.

So where do I sit? Pretty much on the fence, but slightly leaning in Facebook’s direction. I am worried, very worried, but I do slightly lean to the former view that Facebook will find ways to improve their stock price. It seems that every possible disaster and then some are already priced into the stock. But with that said, Facebook is very creative in finding new disasters that no one has even thought of.

Bottom line, with trepidation, I would be a long-term buyer at these levels. It’s just too cheap to ignore. But that is just me and I have a high tolerance for risk. Others can look at this and come away with a completely different conclusion. And they may, in fact, be right.

Time will tell. Next earnings announcement is on April 27th.

Update – Facebook’s April 27th Earnings Announcement

Well there were some benefits to Facebook’s stock getting crushed prior to their earnings announcement. Expectations for the company were astoundingly low. Facebook’s results, while not great, were not a disaster either. And what has followed on the next day of trading is a major relief rally. The stock is up around 17% from $175 to $204 shortly after the market opened on April 28th as I write this.

So how did Facebook do last quarter?

In summary, Facebook exceeded expectations for earnings but missed by a bit on revenue. The sales and EPS for last quarter were as follows (source Bloomberg):

Revenue: $27.9 billion, $324 million less than the $28.24 billion expected.

Adjusted EPS: $2.72, $0.16 more than the $2.56 expected.

Facebook also added users, which was very helpful to the stock, as there was a lot to worry about on that front. The number of daily active users increased 4% to 1.96 billion. That is a big improvement over the prior quarter, where the main Facebook app lost 1 million daily active users.

One more piece of good news for the stock was on the expense side. Facebook expects its total 2022 expenses to range between $87 billion and $92 billion, which is less than the $90 billion to $95 billion range the company had previously announced.

So the net result of it all is a huge lift to the stock price today. It will be interesting to see if this is the beginning of a rally for Facebook, fueled by relief and an inexpensive valuation or whether it turns out to be the biggest dead cat bounce ever. Stay tuned, its going to be interesting!

Note this blog post DOES NOT constitute a recommendation to buy Facebook. Each investor should do their own homework, understand their own investment philosophy and risk tolerance, and make their own decisions accordingly. Facebook is cheap right now. It can also get a lot cheaper.