Facebook (FB 8.10%) stock price continues its march higher. It is currently trading near all-time highs as a substantial percentage of the world's population uses its platforms every month. However, instead of potential user saturation pointing to a slowdown, a strong balance sheet and its continued expansion under challenging conditions may instead be leading to more investors friending this popular communication stock.
Facebook's enviable problem
In the latest quarter, family monthly active people, meaning users who logged on to at least one Facebook app in the last 30 days, rose to 3.3 billion. This accounts for about 42% of the world's population. Such influence attests to Facebook's position as an advertising powerhouse.
However, it points to a problem. With so much of the world using its platforms, logically, these increases could plateau in the foreseeable future, ultimately limiting Facebook's growth potential. This could remind investors of slower-growth companies such as Coca-Cola, which must find new growth even though it operates in nearly all the world's countries.
Image source: Getty Images.
Fortunately, Facebook has found a plausible solution to that problem. Much as Facebook spawned new growth avenues with Instagram and WhatsApp in past years, it has created another avenue for social media growth through virtual reality (VR).
Facebook has created Horizon, a VR world where one can build environments, socialize with friends, or explore virtual worlds. Users access this world through both Oculus headsets and the Facebook network. This gives the company a competitive advantage, as it can combine VR capabilities with a social network unrivaled by other industry players.
Moreover, advertising, which remains its primary source of revenue, continues to surge. Indeed, during the pandemic, the increased user engagement offered only a limited benefit to Facebook as demand for advertising fell. However, during the second half of the year, a shift from services to products provided a tailwind to this business, particularly with products sold via online commerce.
Facebook's financials
The company's financials reflected this growth. Despite struggles in early 2020 amid the pandemic, total revenue came to almost $86 billion, an increase of 22% compared to 2019 levels. A 21% increase in ad revenue accounted for most of the growth. Nonetheless, a 72% surge in "other revenue," primarily referring to VR-related revenue, points to success outside of ads.
Also, net income surged by 58% over the same period to just over $29.1 billion. A 37% drop in general and administrative expenses, meaning costs for salaries, share-based compensation, and professional services, explains most of the net income increase. Facebook spent $5 billion on an FTC settlement in 2019. Had this not occurred, general and administrative expenses would have risen at approximately the same rate as revenue.
Despite this success, Facebook urged caution. The company expects revenue increases to remain steady or increase slightly during 2021. Still, it expressed concerns over implementation related to privacy changes coming with Apple's iOS 14. The company has also mentioned that European regulations could become a headwind if they affect data transfers across the Atlantic.
Still, few companies stand in a stronger position than Facebook to weather adversity. Facebook maintains a solid cash position, having generated more than $23 billion in free cash flow in 2020. Now it holds almost $62 billion in cash and marketable securities. The fact that it holds no debt frees this cash to help Facebook weather unexpected challenges and make new investments.
Due in part to this stability, Facebook stock is quietly hitting new highs. Amid the increases, Facebook's stock price surged by about 80% over the last 12 months.
This takes its P/E ratio to about 31, about 33% higher than its multiple this time last year when stocks began to recover from the massive sell-off in early 2020. Still, the valuation has stayed in a range over the previous four years. Assuming revenue increases remain near the 20%-per-year level, Facebook should at least maintain this P/E ratio over time.
Should I buy Facebook stock?
Despite saturation worries, investors can find a lot to like about Facebook's stock. Time will tell what happens when Facebook can no longer depend on significant user growth. However, ad spending remains strong, and Horizon has shown early signs of success. Even if the earnings multiple stays in a range, its growth indicates Facebook can continue to yield investor returns for some time.
