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After Facebook Stock Surged 40% in 2014, Are Shares Still a Buy?

By Joe Tenebruso - Oct 23, 2014 at 7:11PM

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Is it time to ring the register, or are more gains ahead?

Facebook (META) investors have enjoyed strong gains in 2014, with shares up 40% so far this year. The social media giant has made excellent progress in its transition to a primarily mobile-based business, and has delivered outstanding revenue and earnings growth in the process.

But has Facebook's share price come too far, too fast? Before I answer that question, let's take a look at recent events.

What's happened so far in 2014?
In the first quarter, revenue surged 72% year over year, to $2.5 billion, as Facebook's mobile strategy began to take hold. Mobile monthly active users increased 34%, to 1.01 billion. The effective price per ad displayed increased 118%, which suggests that Facebook's move toward displaying more ads in its News Feed is delivering attractive returns to advertisers. In that regard, management noted on the conference call that, "News Feed ads have significantly higher engagement, click through rates, and price per ad compared to right hand column ads."

That's a net positive for Facebook, as its ad mix should continue to shift toward News Feed ads -- which work well on mobile devices -- and away from traditional desktop-focused right hand column ads. It's also a major reason why Facebook's advertising revenue is likely to experience solid growth for the foreseeable future, as more and more users -- and the advertisers who covet them -- gravitate toward mobile devices.

It was more of the same in the second quarter, with total ad revenue growing 67%, to $2.7 billion, and earnings per share jumping 131%. Mobile ad revenue was again a highlight, surging 151%, with mobile ads accounting for 62% of the company's total ad revenues for the second quarter. Importantly, monthly active users grew 14%, to 1.32 billion. Even better, the average effective price for an ad increased 123%, giving further evidence that advertisers are enjoying solid returns on their investments, and are therefore willing to pay more to advertise on Facebook.

Is Facebook still a buy?
Rather than near its peak, as some might suggest, Facebook, I believe, is still early in its growth cycle. As one example, management noted on the second-quarter conference call that 30 million small businesses use Facebook pages -- but only some 1.5 million of them are active marketers. In addition, another growth catalyst, video ads, are likely to be a major source of incremental revenue in the years ahead.

What's more, Facebook is one of the companies best positioned to profit from the mobile megatrend. Analysts continue to raise their estimates as to just how large the mobile advertising market will become in the years ahead. One thing is for certain, though: The mobile ad market is growing at a rapid pace. And within this enormous and exploding market, Facebook continues to take share from its competitors -- a trend I expect to continue for the foreseeable future.

As a means to further strengthen its core business, Facebook has acquired a stable of valuable, fast-growing properties such as Instagram and WhatsApp. Facebook has only just begun to monetize Instagram with ads, and management has stated that WhatsApp will be unlikely to be a major source of revenue for several years.

As a long-term investor, I see this as more of an opportunity than a negative, and I admire CEO Mark Zuckerberg and his team for holding steadfast in their goals to create long-term value to users, customers, and shareholders. And with a war chest of nearly $14 billion, Facebook continues to have plenty of ammunition to acquire new technologies and talent.

Looking ahead, as the number of users on Facebook's network continues to expand, advertisers will increasingly flock to Facebook for its massive global reach. As long as companies continue to earn strong returns on their advertising investments on Facebook's platform, they are likely to allocate a growing portion of their marketing dollars to the social media titan.

With an excellent management team, a valuable collection of fast-growing networks with massive user bases, and a fortress-like balance sheet that will allow it to continue to invest aggressively in new opportunities, Facebook remains Tier 1 in its industry. As such, investors who buy shares today stand to profit handsomely in the years ahead. And so, at least 24 hours after this article is published -- standard operating procedure for The Motley Fool's Real-Money Stock Picks program that's designed to give Fools the opportunity to buy ahead of us should they so choose -- I will buy shares of Facebook in the Tier 1 portfolio.

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