In the aftermath of the coronavirus market crash, there are some good buying opportunities for investors willing to deploy some capital during these uncertain times. Indeed, many stocks are still down double-digit percentages from recent highs.
One stock worth taking a closer look at to see whether or not it's a good buy today is Facebook (FB 1.06%). After all, shares are down about 15% from an all-time high earlier this year. Is this a good time for investors to buy shares of the lucrative social network?
Facebook CEO Mark Zuckerberg. Image source: Facebook.
Sure, Facebook's ad revenue is likely taking a hit as some marketers reduce ad spend in the wake of many store closures and consumers sheltering at home. But when investors zoom out beyond these temporary challenges, Facebook isn't only highly profitable, but it's also growing rapidly. This pullback in the company's stock price, therefore, may be giving investors a good chance to buy shares of this quality company at a good price.
Let's take a closer look to see if investors should buy, sell, or hold Facebook shares today.
Valuing Facebook stock
Since Facebook's initial public offering in 2012, the social network has not only continued growing rapidly, but has also morphed into a cash cow. The company's annual free cash flow, or cash from operations less capital expenditures, has risen from $6 billion in 2015 to $21.2 billion in 2019. Net income has similarly soared, rising from $3.7 billion in 2015 to $18.5 billion in 2019.
This growth is expected to continue in the coming years, with analysts predicting that Facebook's earnings per share can grow at an average rate of 14.3% annually over the next five years.
Considering both Facebook's historical performance and analysts' optimistic view for the social network's profitability over the next five years, an investor can piece together a rough fair value estimate for the stock today based on reasonable estimates of future cash flows. Assuming Facebook's annual free cash flow grows at an average rate of about 10% over the next five years, 8% annually during the five years beyond that, and approximately 3% in perpetuity, the present value of these cash flows when discounted by a 10% rate (to account for the time value of money and the risks of buying stocks) comes out to $204 per share. This means that shares are currently about 7% undervalued based on these estimates.
This discounted cash flow valuation model, of course, is oversimplified. But it still highlights one key point: It's fairly easy to justify the stock's price tag today based on estimates that are arguably conservative in light of the company's recent growth and analysts' consensus expectations.
Two key catalysts: Stories and international markets
I'd argue that shares of the tech stock are actually worth more than $204. This is because the company has some very impressive catalysts that could build momentum in the coming years and give Facebook's revenue and profits a substantial boost.
Facebook's underappreciated catalysts are its stories format across all of its social networks (Instagram, WhatsApp, Messenger, and Facebook), and the upside potential for improved monetization in international markets.
In Facebook's fourth quarter, advertising revenue jumped 25% year over year, driven primarily by a 31% year-over-year increase in ad impressions across its services. Revenue would have been up even more but prices per ad declined on a year-over-year basis as the company's mix of ad impressions shifted toward ad units on stories and in international geographies -- two areas that monetize at lower rates. But there's no reason to believe that, as these two areas of Facebook's business mature and as international geographies develop, stories and international ad units won't become more valuable over time.
Image source: Getty Images.
Stories (a media format that doesn't stick around permanently) looks like a particularly promising ad format. Advertisers are certainly buying into it -- probably because the format is typically full screen and is viewed by a highly engaged user.
Advertisers using stories hit 4 million in Q4, up from 2 million in the fourth quarter of 2018. Further, Facebook confirmed that users are increasingly favoring this format, with management noting in the company's fourth-quarter earnings call that, "the greatest growth in how people are communicating continues to come from private messaging, small groups, and disappearing stories where your data doesn't stick around forever."
In addition, ad revenue per user is still significantly lower in markets beyond the U.S. and Canada. Average revenue per user in the U.S. and Canada during Q4 was $41.41. This compares to $13.21 in Europe, $3.57 in Asia-Pacific, and $2.48 in the company's "rest of world" segment. As the gap in revenue per user between these international markets and the U.S. and Canada closes, this will likely propel significant growth for Facebook for years to come.
Should you buy Facebook stock now?
Given the stock's conservative valuation and two powerful growth opportunities in the company's stories format and international markets, this sell-off presents investors with a good opportunity to take a position in this fast-growing cash cow.
Of course, there's no way to guarantee shares won't fall from here. This is particularly true today, when Facebook and the broader advertising industry are navigating unique and unchartered challenges.
But as COVID-19 fades into the rearview mirror, Facebook should come out of this pandemic strong and capable of delivering rapid top- and bottom-line growth over the long haul. Investors willing to buy shares now and hold for years to come will likely be rewarded handsomely.
