Facebook’s (FB) historic roughly 20% drop in the wake of its post-market earnings on July 25 and then during the trading day on July 26 is already showing signs of recovery. Since July 26, the stock is up 3.94% and up 7.10% from its recent low on July 30.
As we’ve seen with Facebook in the past, when there are sudden negative market panics on the basis of positive but not euphoric news, it often bounces back soon enough. In this case, Facebook’s guided-for earnings growth and at around its lowest P/E in history mean the company seems quite cheaply valued in a way that likely will soon prove the bears wrong again.
Facebook’s “Drop And Recovery” Move Seemingly A Staple Of The Stock
It seems like this yo-yo action is a characteristic of Facebook stock, as a massive sell-off happens amid worries over user metrics, platform changes, or revenue reevaluations that sends the stock plummeting as if it were some small-cap startup that found its way to the public markets.
In early 2014, Facebook stock dropped almost 5% intraday after its purchase of WhatsApp, seemingly over worries about stock dilution. Though the company initially bounced back, it ended March down 11.5% at what now seems an incredible mere $60 a share. It would end 2014 at $78.02 a share or up 14.63% from the day it announced its WhatsApp purchase.
In November 2016, Facebook would suffer another major drop, in seemingly déjà vu to the current situation, falling about 5.64% to $120 a share after its earnings report which showed positive earnings and revenue results but featured lower growth guidance. By the end of 2017, it would, however, be up to $176.46 a share or +47.05%.
Then, we even can look at Facebook’s IPO of $35 a share back in May 2012, whereupon it dropped on its first trading day over 10% to just $32 a share before ending May at $29.60 a share and spending the next few months at around $20 a share.
The message of all of these historical tidbits is that Facebook seemingly has significant market jitters when its growth expectations are changed or some fundamental factor has shifted, as it seems to still be seen as a very delicate tech stock whose entire business could be subject to small industry whims and regulatory changes.
Undoubtedly, Facebook is a very particular business that relies on some key metrics, specifically user activity and data collection and usage. Indeed that’s why after Cambridge Analytica I believed the threats to Facebook were serious and real this time, even if it again defied the naysayers and pulled back from its then 13% drop from mid-March to the end of March.
Is This Time Different For Facebook?
Looking beyond 2018, we anticipate that total expense growth will exceed revenue growth in 2019. Over the next several years, we would anticipate that our operating margins will trend towards the mid-30s on a percentage basis.
Those words by Facebook CFO David Wehner on the company’s Q2 2018 conference call were what sent the stock spiraling, particularly when compared to the Q2 2018 margin of 44% or Facebook’s FY 2017 margin of 50%, up from its FY 2016 margin of 45%.
(Source: Facebook Q2 2018 Earnings)
A contraction of margin from 44% to the mid-30s means that the expense growth guided for must really be significantly higher than revenue growth. While expense growth for this quarter is already higher year-on-year, at 50%, than revenue growth, at 42%, it is worth noting too that in FY 2017, revenue growth was at 47% to expense growth at 34%.
(Source: Facebook Q4 2017 and FY 2017 Earnings Report)
This is also in contrast to Q3 2017, the aforementioned drop and bounce, where Facebook still had year-on-year revenue growth of 47% to expense growth of 34%.
Every situation is unique and undoubtedly the cost increases Facebook is facing may cause a change in what was originally believed to be Facebook’s earnings trajectory, particularly after the post-Cambridge Analytica run up of the stock. However, I think the reaction remains overblown – specifically because of what the cost increases actually are for.
Looking closer, we see that the cost increases seem to be largely for increased content moderation in terms of both algorithmic development and actual human content moderators. Facebook has avoided major government intervention in the wake of Cambridge Analytica seemingly by focusing more seriously on self-regulation, which means that the company will avoid the major regulatory risks initially present after its data scandal.
Furthermore, increased content moderation may mean better user and advertiser trust of the platform in the long-run as the company re-invigorates user activity through new services and the ever-growing Instagram as well as finds new monetization opportunities through both ad placement and subscriptions.
Online advertising continues to grow and still is bolstering much of the advertising-reliant Internet services industry (FDN), of which Facebook still is well-positioned to capture portions of that growth.
Facebook’s, as well as is various parts’, user activity took some hit in growth after Cambridge Analytica but has shown inertia and seems to only have positive factors in its favor as Facebook Watch and its News Feed re-organization bring users back.
A contraction in margin, if it truly does materialize, is undoubtedly priced in already at this point as Facebook sits at its historically low P/E. If the eventual posted results do show a positive surprise, as they very well might be given the aforementioned new services and revenue opportunities, then we could once again see Facebook stock yo-yo back up as it has done so many times in the past.
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Disclosure: I am/we are long FDN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.