Please ensure Javascript is enabled for purposes of website accessibility

Facebook's Growth Is Slowing Down, Yet the Stock Has Never Looked Like a Better Value

By Chad Henage – Feb 26, 2020 at 7:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Facebook stock recently took a 10% haircut after earnings. With a cloud over the company's future, investors have an opportunity to snap up shares at a solid valuation.

It wasn't so long ago that Facebook's (META 0.07%) stock seemed to be a sure thing. Even recently, the stock seemed to be on the way to a nice recovery following the company's missteps on data privacy and other issues. However, investors seemed frustrated with Facebook's latest quarterly results and the shares dropped almost 10% over the next two days. Challenges from expense growth to changes that could hamper Facebook's advertising business have cast a shadow over the stock.

By contrast, Twitter has received its share of criticism over the years. Yet after its earnings report, the shares jumped 15%. At first, it seems like the choice between the two companies has never been clearer. In reality, Facebook's recent setback represents a buying opportunity for long-term investors.

It's a connected world.

Image credit: Getty Images

When challenges meet reality

Facebook generated more than 98% of its quarterly revenue from advertising, so any slowdown is a serious concern. In Facebook's conference call, CFO Dave Wehner delivered several updates that likely contributed to the stock's recent decline.

He said that regulatory impacts would curb Facebook's ability to "utilize signals from user activity on third-party websites and services in order to deliver relevant and effective ads to our users." In case that's not clear, this is corporate-speak for we won't be able to track users' activity, and thus our advertising revenue could run into challenges. If you've ever experienced the surreal situation of looking at an item on Amazon.com or eBay and then magically seeing an ad for it in your Facebook timeline, you've experienced Facebook's use of these "signals."

In addition, the company will be releasing a privacy tool to billions of users. It's reasonable to assume that a portion will adjust their settings to prevent Facebook from tracking their usage of third-party sites. Furthermore, Wehner said, "Apple and Google have announced product changes and future plans that will limit our ability to use those signals."

The bottom line is clear: The less effectively Facebook can track users' activity, "that can negatively impact our advertising revenue growth," in Wehner's words.

What some investors may be forgetting is that even if Facebook's advertising business slows down, it will still likely outperform Twitter's performance in the same area. Last quarter, Facebook generated $20.7 billion in advertising revenue, which increased by 25% year over year. Twitter's advertising revenue reached $885 million and increased by 12%.

Beyond the revenue numbers, Facebook's ad business seems to suggest pricing power. According to Wehner, "total number of ad impressions served across our services increased 31%, and the average price per ad decreased 5%." By point of comparison, Twitter reported that total ad engagements increased 29%, while the cost per engagement decreased by 13%. Said another way, Facebook generated faster transaction growth than Twitter without having to cut prices as far. Even if Facebook's growth slows, it should still handily outperform its peer.

Facebook's future could pay for itself

The growth narrative for Facebook has been that the company's user growth will slow, yet it will capitalize on better engagement and grow advertising revenue. However, comments from management suggest Facebook is finally getting serious about its massive payments opportunity. With billions of people using Facebook's different properties, connecting buyers and sellers as a payments intermediary could open up a whole new revenue stream for the social media giant. 

The company recently started quoting a stat called family daily active people (DAP) that gives investors a sense of the payments opportunity. Last quarter, Facebook's DAP across its properties reached 2.2 billion. With billions of potential payment users, Facebook isn't starting from scratch moving in on new territory. The Instagram property allows users to buy directly from the app. The company hopes that Facebook Pay will become a standard payment method across multiple properties. Inside of the popular messaging app WhatsApp, the company tested payments. CEO Mark Zuckerberg said, "when so many people kept using it week after week, we knew it was going to be big when we get to launch."

The worry for Facebook investors is that this big business may not succeed. Several years ago, Twitter's data licensing division seemed to be the future of that company. With hundreds of millions of users tweeting massive amounts of data, it seemed to make sense that this would be a goldmine. Unfortunately, this business has run into challenges. In last year's fourth quarter, the data business grew by 35% annually. Just a year later, this same segment grew by just 5% year over year.

The key difference between Twitter's data business and Facebook's payments ambitions is scale and user composition. Twitter's vast pool of data is heavily tilted toward those who are the most active on the service, many of whom are celebrities. Twitter seems to lack the personal conversations that Facebook properties have in abundance. When a celebrity tweets, the response might be a thousand or two thousand replies, yet there is little real conversation.

Where Facebook is concerned, real interactions between friends and family members give the company significant data about where people are and what they are spending money on. Though Facebook's brand has been tarnished because of past security issues, its other properties don't have the same stigma. WhatsApp has an estimated 2 billion users. If only 10% of users started making payments, this property alone would quickly become a significant threat to payments players like PayPal, Square's Cash App, and more.

The valuation calculation

Over the last several years, it has been difficult to think of Facebook's stock as cheap. For the first time in a while, the combination of tempered expectations and a realistic growth narrative give investors a chance to buy the stock at a solid value.

If we look at Facebook and Twitter side by side, the better investment nearly jumps off the page.

Measurement

Facebook

Twitter

2020 Projected P/E ratio

18

34

2020 Projected revenue growth

21.2%

15.4%

5-year annual EPS growth

13.2%

13.9%

3 month core operating cash flow growth

8.6%

(35.7%)

Net cash balance and annual growth

$54.9 billion +33.6%

$3.5 billion (22.2%)

(Source: Yahoo Finance for forward P/E ratios; analyst estimates for P/E, revenue growth and five-year EPS projections; three-month operating cash flow growth and net cash results author's calculation from most recent earnings release.)

In short, Facebook offers a forward P/E ratio that is nearly half that of its peer yet is projected to grow earnings at nearly the same rate. While Facebook grew its operating cash flow and net cash, Twitter witnessed a decline by both measures.

If we follow famed investor Warren Buffett's advice to "be fearful when others are greedy and greedy when others are fearful," the short-term worries about Facebook suggest a long-term opportunity. Facebook's growth may be slowing down, yet the stock has never looked like a better value.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Chad Henage owns shares of Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Amazon, Apple, Facebook, PayPal Holdings, Square, and Twitter. The Motley Fool recommends eBay and recommends the following options: long January 2021 $18 calls on eBay, short January 2021 $37 calls on eBay, and short March 2020 $70 puts on Square. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
META
$139.07 (0.07%) $0.09
Apple Inc. Stock Quote
Apple Inc.
AAPL
$145.43 (-0.66%) $0.97
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$101.42 (-0.01%) $0.01
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$120.30 (-0.54%) $0.65
eBay Inc. Stock Quote
eBay Inc.
EBAY
$38.89 (-0.59%) $0.23
Twitter, Inc. Stock Quote
Twitter, Inc.
TWTR
$49.39 (-3.72%) $-1.91
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
PYPL
$94.42 (0.63%) $0.59
Block, Inc. Stock Quote
Block, Inc.
SQ
$61.93 (-0.35%) $0.22

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
338%
 
S&P 500 Returns
108%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.