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Is It Finally Safe to Buy Facebook Inc. Stock?

By Leo Sun – Nov 3, 2018 at 10:32AM

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The social media giant isn’t headed off a cliff, but it still faces stiff headwinds.

Facebook (META -1.19%) has had a tough year, as concerns about slower growth, privacy concerns, executive departures, and rising interest rates have caused the stock to shed nearly 15% of its value. However, the company recently allayed some of those fears with a mixed third quarter report (released Oct. 30) and better-than-expected guidance.

Facebook's revenue rose 33% year over year to $13.73 billion, which slightly missed expectations and marked the company's slowest growth rate since its IPO. Net income rose 9% to $5.14 billion and its earnings per share (EPS) grew 11% to $1.76, beating estimates by $0.30.

Facebook CEO Mark Zuckerberg.

Image source: Facebook.

For the fourth quarter, Facebook expects its revenue growth to decelerate by a "mid-to-high single-digit" percentage compared to its third quarter. This is slightly better than the company's forecast during the second quarter, which called for "high single-digit" percentage declines for several quarters. But will that minor improvement help Facebook's stock finally recover?

Facebook's key growth figures

Facebook's advertising revenues rose 33% (35% on a constant currency basis) over the prior-year quarter, and accounted for 99% of its top line. Its ad revenue rose 33% in North America, 34% in Europe, 38% in the Asia Pacific region, and 26% across the rest of the world. Mobile advertising revenue improved by 40% and accounted for 92% of total advertising revenue, compared to 88% in the third quarter of 2017.

Facebook's monthly active users (MAUs) rose 10% year over year to 2.27 billion, and its daily active users (DAUs) grew 9% to 1.49 billion. Its DAU growth was flat in the U.S. and Canada, likely due to market saturation and the recent privacy and security issues, but overall growth remained impressive for three reasons.

First, Facebook is still growing at a faster rate than smaller social networks like Twitter (TWTR) and Snap (SNAP -3.51%). Twitter's MAUs dropped 1% versus the prior year to 326 million last quarter as its DAUs grew 9%. Snap's DAUs improved by just 5% to 186 million last quarter.

Second, Facebook's MAU and DAU counts don't include users on Messenger, WhatsApp, and Instagram. Facebook estimates that over 2.6 billion people use this family of apps every month, and over two billion people use at least one of these apps daily.

Lastly, Facebook's user growth indicates that its recent privacy and security issues aren't causing users to shun the app in other countries. Facebook attributed most of its DAU growth to new users in India, Indonesia, and the Philippines -- three high-growth markets that probably aren't concerned about the company's challenges in the US.

A cloud of social networking connections.

Image source: Getty Images.

Analyzing the headwinds

Facebook attributes its decelerating sales growth to three main issues: a higher dependence on services and geographic regions with lower monetization rates than the U.S. and Canada, data privacy initiatives which are throttling near-term growth in ad prices, and the expansion of Facebook Stories, which is displacing other ad impression opportunities.

In other words, Facebook's development of new products and its expansion into new markets will cause its near-term growth to slow down. However, its growth could accelerate again once those initiatives take hold. This contradicts the bearish argument that Facebook's sales growth will decline as its user expansion stalls out.

Facebook's total cost and expenses rose 53% to $7.95 billion during the quarter and equaled 58% of its revenues, compared to 50% in the prior-year quarter. The organization reported an operating margin of 42.1% during the quarter, compared to 49.6% a year ago.

For the full year, Facebook expects its total expenses to rise 50%-55%, which represents an improvement from its prior forecast of a 50%-60% increase. Looking further ahead, Facebook expects its total expenses to grow just 40%-50% in fiscal 2019.

That's also encouraging, since it indicates that Facebook's spending -- which is being directed toward new platforms, products, privacy controls, and the expansion of its data center infrastructure -- will decelerate over the long term.

Facebook expects its long-term operating margins to drop to the mid-30s range. But during the company's earnings conference call, CEO Mark Zuckerberg noted that the changes to its business that are currently weighing down its margins would help Facebook become "a lot better positioned" next year.

So has Facebook finally bottomed?

Facebook's third quarter report wasn't stellar, but it didn't indicate that the company is turning into the next Myspace. Analysts expect its revenue and earnings to rise 25% and 15% next year, respectively, which are still robust growth rates for a stock that trades at 18 times forward earnings.

I'm not saying that Facebook's stock has finally bottomed, but I think that it can stabilize at these levels -- as long as it avoids other privacy debacles and nurtures higher-growth platforms like Instagram and newer services like Watch and Stories.

Leo Sun owns shares of Facebook. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has the following options: short November 2018 $155 calls on Facebook and long November 2018 $135 puts on Facebook. The Motley Fool has a disclosure policy.

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