When it comes to outperforming analyst expectations, Facebook, Inc. (META -1.31%) has been crushing it -- at least during the past few years. The social network has consistently outperformed expectations on both revenue and EPS. Can the social network pull it off again for Q3?
As the social network's third quarter comes to a close on Friday, and ahead of the company's third-quarter earnings release, it's a good time for investors to consider whether or not investor expectations have soared too high.
Three narratives for Facebook investors to mull over
As Facebook wraps up its third quarter, here's some background on keys aspects of the social network's business that investors should understand.
1. Revenue growth. Facebook's revenue has been skyrocketing. Not only is the company's year-over-year revenue growth of 59% in its most recent quarter impressive in and of itself, but for four quarters straight this metric has either increased or remained the same sequentially. Facebook's year-over-year revenue growth four quarters ago was much lower, at 39%. Investors would have never guessed the social network's already rapid revenue growth would accelerate significantly between the second quarter of 2015 and the second quarter of 2016.
But as Facebook's video advertising products -- which have been a major driver in the company's rapidly growing revenue -- mature, and as the social network shifts to a greater emphasis on ad quality over ad load, it's not clear Facebook can keep up this blazing growth.
2. Operating margin growth. Another area Facebook's business has benefited hugely from recently is its soaring operating margin. In Facebook's most recent quarter, Facebook's GAAP and non-GAAP operating margins increased from 31% to 43% and from 55% to 58%, respectively.
Sustaining impressive operating margin growth may not be as easy going forward, as it's not disciplined operating expense management leading to a wider operating margin, but rather the company's wild revenue growth. With revenue soaring 59% in the company's most recent quarter, even 33% and 47% increases in GAAP and non-GAAP costs and expenses, respectively, weren't enough to weigh on operating margin.
3. Net income. With revenue growth soaring and operating margin expanding, Facebook's bottom line benefits. In the company's most recent quarter, net income increased 186% year over year to over $2 billion. But investors should know that this growth is not sustainable.
The main idea investors should contemplate regarding all three of these areas of Facebook's business is that these metrics' recent impressive levels of growth simply aren't sustainable over the long haul. In addition, Facebook's stellar operating margin expansion and net income growth are directly tied to the company's recent ability to deliver mind-boggling revenue growth. So, if revenue growth begins to decelerate, operating margin improvements could slow or even come to a halt and net income growth would quickly come down to earth.
On the other hand, while there's a chance Facebook's recent business growth could soon decelerate to more moderate levels, the social network hasn't given investors any reason to lose faith in the company -- even at a price-to-earnings ratio of about 62. So, investors shouldn't sell Facebook stock simply because the company may not be able to keep up recent growth. But investors should at least keep in mind the risks to Facebook's current growth trajectory for its business. At some point, Facebook's growth will have to slow.