According to eMarketer, the digital advertising market will grow by 11.6% annually between 2019 and 2023. Both social media companies Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR) are poised to profit from this secular trend. Over the last several years, Facebook outpaced Twitter in terms of revenue growth and profits, which translated into Facebook's superior stock price performance. But since both companies now face different challenges, let's see whether Facebook remains a better buy for long-term investors.
Facebook's stellar performance
After some uncertainties around the monetization of its mobile audience at the time of its IPO in 2012, Facebook has rewarded early investors with a stellar performance so far. The company estimates that 2.2 billion people use one of its core platforms (Facebook, Instagram, WhatsApp, or Messenger) every day on average. And despite its huge scale, revenue -- mostly from advertising -- still increased by 29% year over year during the last quarter, reaching $17.65 billion.
However, the social media giant neglected its users' data privacy along the way -- the Cambridge Analytica scandal comes to mind -- and the Federal Trade Commission (FTC) charged the company with a penalty of $5 billion.
The FTC decision comes with extra scrutiny, and management forecasted an increase in total expenses to the range of $54 billion to $59 billion in 2020 to address security and privacy issues along with supporting growth. Yet even with this headwind, the midpoint of management's guidance represents an impressive operating margin of 34.1%, based on analysts' revenue estimates.
Besides, Facebook is trying to diversify away from its traditional advertising business model by taking advantage of its huge user base. For instance, the company is developing payment, video, and gaming products.
Twitter's scale disadvantage
Even with its strong 17% increase in monetizable daily active users (mDAU) during the last quarter, Twitter's average 145 million mDAUs pales in comparison to Facebook's billions of daily active users. Also, because of its smaller scale, Twitter's operating margin -- 5% during the last quarter -- remains much lower than Facebook's operating margin, which is way above 30%.
Twitter has drastically reduced its research and development (R&D) expenses as a percentage of revenue over the last several years to improve its profitability. As a result, both companies spent a similar percentage of their revenue on their R&D expenses during the last quarter. But given its smaller scale, Twitter's R&D expenses of $484 million since the beginning of the year can't give the company a competitive advantage when compared to Facebook's R&D spending of $9.7 billion over the same period of time.
Besides, Twitter recently faced execution issues that will negatively impact its results, at least in the short term.
In addition, the involvement of CEO Jack Dorsey remains a significant uncertainty for shareholders. Since he's also CEO of the payment company Square, he might not give Twitter his full attention. Besides, he announced he'd moved to Africa for a few months next year -- when the company will most likely face extra scrutiny during the next U.S. presidential election.
Facebook should remain a better buy than Twitter
Based on the enterprise value-to-sales ratio, the market values Facebook at a premium because of its higher profitability. However, if you look at some other metrics such as enterprise value-to-EBITDA and forward P/E ratios, Facebook becomes much cheaper than Twitter.
Both social media platforms are exposed to different challenges. With its dominant position, Facebook is facing extra regulatory scrutiny with a threat of dismantlement. In contrast, Twitter's issues mostly remain under its own control.
But considering that both companies are exposed to the same online advertising market, Facebook's scale advantage and lower valuation provide long-term investors with a better margin of safety. Thus, Facebook remains a better buy than Twitter.