5 Things to Like About Facebook's Earnings

Investors give Facebook's earnings the thumbs-up -- with good reason

Jan 29, 2014 at 7:00PM

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

After a day of respite, U.S. stocks resumed their decline on Wednesday, as the benchmark S&P 500 index fell 1%, while the narrower Dow Jones Industrial Average (DJINDICES:^DJI) lost 1.2%.

In the run-up to its highly anticipated fourth-quarter earnings announcement this afternoon, Facebook's (NASDAQ:FB) stock underperformed the market, with a near 3% drop. However, that loss looks likely to reverse tomorrow, as better-than-expected results have the shares up 12% in the after-hours session.


The numbers
Facebook beat Wall Street expectations by a solid margin on both revenue ($2.59 billion versus a consensus estimate of $2.33 billion) and earning per share (adjusted EPS of $0.31 vs. $0.27). The company flexed its profitability muscle in the fourth quarter, with GAAP and non-GAAP operating profit margins of 44% and 56%, respectively -- their highest levels in at least two years. That enabled the company to generate nearly three-quarters of a billion dollars in free cash flow, for a total of $2.89 billion in 2013. Facebook is quickly becoming a well-oiled profits engine.

Starting with the first quarter of 2013, Facebook began reporting the number of daily active users above the number of monthly active users in its earnings press releases. In this latest release, mobile daily active users take precedence over monthly active users, too, which reflects the shift in the company's focus (more in a moment on the shift to mobile). While the 1.23 billion sounds extremely impressive (it's no small feat, to be sure), it's the daily active users that will drive the business, since they are the eyeballs advertisers are paying for.

On this front, the trend also looks positive, as daily active users rose 22% year-on-year to 757 million, while mobile daily active users grew 49% to 556 million. Better yet, engagement, as measured by the ratio of daily active users to monthly active users, inched up one percentage point in the fourth quarter 62% -- in other words, the number of "power-users" grew faster than those who consult Facebook occasionally.

The teen question
Recall that during the last earnings call, CFO David Ebersman precipitated a $16 billion drop in the company's market value during the after-hours trading session when he mentioned that the number of teens on Facebook had remained constant between the second and third quarters and that the number of younger teens on Facebook had actually fallen. During today's call, one of the analysts asked about teens, but management responded that there was no new data to report.

A number of studies have looked at teenagers' use of Facebook recently, and although they are often mentioned in the press under rather alarmist headlines, there is little evidence of a teen exodus (although there are indications that the way in which this demographic uses Facebook is changing).

Mobile works!
The fourth-quarter results put the last nail in the coffin of the idea that the shift from PCs to mobile devices would harm Facebook's nascent advertising franchise. That idea had dogged the stock since it became publicly traded through the first half of 2013. Last quarter, however, Facebook achieved a symbolic milestone, as mobile ad revenues made up more than half (53%) of total ad revenues.

Move deliberately and get things right
In the letter to investors he included in Facebook's IPO prospectus, Mark Zuckerberg touted the company's in-house exhortation to "move fast and break things", so it is somewhat surprising to see how just how deliberately it is implementing the rollout of video ads. This is in spite of the fact that marketers want to use video more, according to COO Sheryl Sandberg. To their credit, Facebook's management understand they need to treat the "user experience" with kid gloves (you don't want to break it!). Too many videos with too little relevance to the user is a recipe for disaster. "Quality over quantity" is the aim and this pertains to the "ad load," too (the number of ads in a user's news feed).

This is a fine example of Facebook's willingness to sacrifice short-term gains to build longer-term value -- an impressive display of managerial maturity for a platform that celebrates its 10th birthday next week. Facebook has put together a great quarter that caps a transformational year for the company, both in terms of its business and investors' perception of the business. Maintaining the focus on user satisfaction will set the foundation for healthy growth of its franchise and ensure it remains a formidable competitor for digital advertising dollars.

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Alex Dumortier, CFA, has no position in any stocks mentioned; you can follow him on Twitter: @longrunreturns. The Motley Fool recommends and owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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