Facebook Shoots the Lights Out -- What's Not to Like About the Stock?

Facebook reports impressive second-quarter results, but there's still a hitch.

Jul 23, 2014 at 7:00PM
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The march to 2,000 continues for the S&P 500! U.S. stocks finished higher on Wednesday, with the benchmark S&P 500 achieving a new record high off an 0.2% gain. Meanwhile, the narrower Dow Jones Industrial Average (DJINDICES:^DJI) fell 0.2%, while the technology-heavy Nasdaq Composite Index (NASDAQINDEX:^IXIC) was up 0.4%. And speaking of all-time highs, shares of Facebook (NASDAQ:FB) rose 2.9% today in the run-up to this afternoon's second-quarter results, and they're rising yet further in the after-hours session, hitting a record high in the process -- something that ought to be replicated during tomorrow's session.

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In reviewing Google's (NASDAQ:GOOG) second-quarter results last week, I highlighted that Facebook is growing its mobile advertising revenues faster than the search colossus. Today's numbers from Facebook illustrate that phenomenon and helped the social networking company power ahead of Wall Street's expectations:

Metric

Actual/Year-on-Year Growth

Analysts' Consensus Estimate

Revenues

$2.9 billion

+61%

$2.8 billion

Earnings per share

$0.42

+121%

$0.32

Sources: Facebook, Thomson Financial Network.

In the second quarter of last year, Facebook beat expectations and simultaneously put to rest fears that its advertising franchise might not successfully negotiate the transition from PCs to mobile devices. One year on, and the evidence is that the business has gone from strength to strength, with mobile advertising now contributing 62% of total ad revenues, up from 41% in the year-ago period. Facebook ate up one-fifth (18%) of the global advertising market, according to research firm eMarketer, which is forecasting that proportion to grow to 22% this year.

The motor of mobile advertising contributed to the 61% year-on-year growth rate in total revenues -- superb performance for a company that size. (However, note that in the second half of 2006, when Google hit the same level of quarterly revenues, its year-on-year growth rate was a bit higher, at roughly 69%.) Combine that with improved margins -- all four major cost categories were lower as a percentage of revenues than they have been in the prior four quarters -- and you have a recipe for the "pop" in profits.

Given these stellar numbers, is there anything for investors to dislike about Facebook? The main problem I have is not with the business itself, but with the valuation the market is assigning to that business. At 39 times the earnings-per-share estimate for 2015, the shares don't have a margin of safety (or, rather, the margin of safety is negative -- a "margin of danger"). Perhaps the company will continue to grow at a pace that will see that concern off in time, but that is the assessment of this value-driven investor today.

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Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Facebook, Ford, Google (A and C shares), and Tesla Motors. 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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