Facebook, Inc.'s Profits Surge and Its Stock Falls

Image source: Facebook.

Maintaining its long-standing streak of astounding revenue and profit growth, Facebook (META -1.12%) announced another record quarter on Wednesday evening, yet the stock is trading lower.

Here's a look at the social network's third-quarter results, as well as a look at what may have sent shares lower.

The raw numbers

Facebook's top and bottom line both skyrocketed. Revenue surged 56% to $7 billion and net income jumped 166% to $2.4 billion. Further, Facebook's adjusted EPS, which management believes is a better representation of the company's regular operations, increased 91% to $1.09.

These results were also well ahead of analysts' expectations. On average, analysts were expecting Facebook to report revenue and adjusted EPS of 6.92 billion and $0.97.

Facebook's financial results demonstrated how the social network continued to benefit from operating leverage, with the company's operating margin expanding from 32% in the year-ago quarter to 45% as operating expenses increased at a significantly slower rate than revenue.

Other highlights

Facebook users increased nicely: Monthly and daily active users on Facebook's core social network increased 16% and 17%, respectively. This put monthly and daily active users at a record 1.79 billion and 1.18 billion.

Engagement remained high: With daily active users increasing more rapidly than monthly active users during the quarter, Facebook's engagement rate (daily active users as a percentage of monthly active users) increased from 65% in the year-ago quarter to 66%.

Facebook is a cash cow: During Facebook's third quarter, the company generated an impressive $2.5 billion in free cash flow. Further, the company's growing free cash flow helped the social network's sizable position of cash and investments swell to $26.1 billion.

Slower growth and higher spending ahead

Image source: The Motley Fool.

Despite what seemed to be an all-around excellent quarter, the market responded pessimistically to the report. Shares fell about 7% in after-hours trading following the earnings release.

The Street's bearish response likely stems -- at least in part -- from Facebook's warning about slower growth in the coming quarters.

"We continue to expect that revenue growth rates will decline in Q4 as we lap a strong fourth quarter in 2015," Facebook CEO David Wehner said during Facebook's earnings call. And, for 2017, Wehner forecasted more deceleration:

As I mentioned last quarter, we continue to expect that ad load will play a less significant role driving revenue growth after mid-2017. Over the past two years we have averaged about 50% compound revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully.

Interestingly, however, Facebook management was already warning about a coming deceleration in revenue growth. So, it's no surprise that Facebook's monstrous growth rates are likely to fall in the company's fourth quarter and beyond.

Another possible reason for the stock's post-earnings sell-off could be Wehner's note about expectations for 2017 to be "an aggressive investment year."

Wehner continued:

Adding top engineering talent remains one of our key investment priorities as we continue to execute on our 3-, 5- and 10-year roadmap. We will continue to invest in our ability to recruit top technology talent both in the Bay Area and beyond.

Overall, Facebook's third quarter highlighted more strong performance from the social network. Rapidly rising revenue, improving operating leverage, and higher user engagement emphasized the strength of the company's network effect. And while management anticipates slower revenue growth and aggressive investments ahead, these narratives are consistent with the company's ambitious vision to connect the world.