Hedge Funds Are Buying Facebook -- Should You Be Following Their Lead?

Source: Facebookbrand.com.

Big hedge funds have been scooping up shares of Facebook (META -1.12%) over the past few months, even as the stock hovers around its all-time high. Should we be following suit and making the social network a piece -- or a bigger piece -- of our portfolios?

While we should never blindly follow the moves of hedge fund managers or other big-name investors, we can use their actions to further investigate potential investments. And in the case of Facebook, there are good reasons to consider following their lead.

First, let's take a quick look at the hedge fund activity that's been in the news.

A top holding, but a pricey one

FactSet Research recently issued a report noting that the top 50 funds bought more than $3 billion worth of Facebook shares during the first quarter. Viking Global Investors was the largest buyer, followed by hedge fund Citadel. Facebook is now the top holding of hedge fund Coatue Management, the report noted.

Fund managers haven't exactly been picking the stock up on the cheap. Shares are up more than 25% over the past four months, even as the overall market has moved sideways, and they are again approaching their all-time high.

At $119, shares trade at more than 73 times trailing-12-month earnings. No way around it, Facebook is a richly valued stock.

But for investors with a tolerance for risk, it also offers tremendous opportunity for growth. The social network is positioning itself to capitalize on major trends in advertising, which should pay off for years to come.

Facebook dominates mobile

Facebook invested in mobile technology ahead of its competition, and the move has paid off in spades. While mobile advertising was seen not long ago as a less-lucrative little brother to the desktop market, it's now poised for much bigger growth. Mobile ad spending should overtake desktop this year, and by 2017 it is projected to reach twice desktop's size, according to eMarketer.

Facebook's ad revenue grew 57% last quarter, and mobile ads drove virtually all of that growth. Mobile now makes up some 82% of Facebook's ad revenue, which is nine points higher than a year ago.

Video in your pocket, ads on your screen

Although Alphabet's YouTube is nearly synonymous with desktop video, Facebook is building a commanding position on the mobile side. The social network is putting more video into your News Feed every day and, in doing so, is helping to establish a strong ad platform moving forward.

The company has recognized that marketers and advertisers are willing to pay more for video ads and interactives that include video than for static ads. The mobile video ad market is expected to more than double in the coming three years, according to eMarketer, and Facebook is positioning itself to capture a sizable amount of that new growth.

Scaling out ad tech to smaller businesses

Facebook has some 3 million businesses advertising through its site and mobile apps today. But there are also more than 50 million businesses that maintain Facebook pages, including many small businesses with small advertising budgets.

The social network aims to continue converting those remaining 47 million into paying advertisers. How? By developing superior ad tech that allows businesses to target the right customers with the right ads and to measure their return on investment.

It develops that technology to serve big companies, but it does so with an eye on eventually scaling it out to smaller businesses -- right down to Main Street mom-and-pop shops that may not have been able to afford much more than an occasional ad in a local newspaper. That leaves a long runway for growth.

An eye on the future

Facebook thinks long-term. It continues making investments in areas that offer little benefit to the bottom line today but hold the potential to be transformative in the long run. We can see that in its development of the Facebook Lite platform that has put its apps in the hands of 100 million users in the developing world, where only low-speed wireless connections are available.

We can see it in its development of virtual-reality technology that today may be reserved for hardcore gamers but in the future could be a key advertising platform.

But not without risk

As a business that relies almost entirely on advertising revenue, Facebook will continue to operate across a very competitive landscape. As much as it's served to disrupt areas of the ad market, it's also susceptible to disruption itself.

Investors will want to keep a close eye on the progress Facebook is making in those important areas -- as well as the progress that's being made by its competitors. At a premium today, it's a buy that comes with risk, but it's a risk that can pay off for years to come.