Facebook (NASDAQ:FB) stock has climbed 30% over the past year, handily outperforming the NASDAQ's 22% gain. But after that big rally, does the stock still have room to run? To answer that question, let's do a simple SWOT (strengths, weakness, opportunities, and threats) analysis of Facebook's business.
Facebook, the world's largest social network, has 1.44 billion monthly active users (MAUs) worldwide. Unlike rivals Twitter (NYSE:TWTR) or LinkedIn (NYSE:LNKD.DL), Facebook is consistently profitable on a GAAP basis.
Last quarter, mobile advertising revenue accounted for 73% of Facebook's advertising revenues, up from 59% in the prior year quarter. Total ad revenues rose 46% annually as its average revenue per user (ARPU) climbed 25% to $2.50. Unlike Google, Facebook limits the number of ads it displays every quarter. This strategy -- which emphasizes quality over quantity -- caused Facebook's average price per ad to soar 285% annually last quarter as ad views fell 62%.
Research firm eMarketer estimates that Facebook generated $3.54 billion in mobile display ad revenues in the U.S. last year, more than triple Google's $1.13 billion. Unlike Google's scattered network of display ads, most Facebook ads are displayed within its News Feed.
Last year, Facebook beefed up its video delivery platform for video ads, and launched its own embedded video system to challenge Google's YouTube. Facebook uses single-sign ons (SSOs) in third-party apps and sites to tether users to its News Feed, which gathers data for marketers. Thanks to its strength in social, users are often more inclined to use Facebook's SSOs instead of Google's.
Despite those strengths, critics have questioned Facebook's "conversion rate," which measures whether or not purchases or marketer-specified actions occur after an ad is clicked.
Research firm Marin Software reported that 63% of clicks on Facebook ads came from mobile devices during the fourth quarter of 2014, but only 34% of conversions occurred on smartphones and tablets. Meanwhile, the click through rate (CTR) of Facebook ads is consistently lower than the CTR for Google AdWords. Those two weaknesses, combined with soaring ad prices, have caused smaller businesses to question the price effectiveness of Facebook ads.
Another key question is whether or not Facebook can keep growing. Last quarter, MAUs rose 13% annually, but that figure has ticked lower every quarter. If MAU growth hits single digits, Facebook will need to rely more heavily on ARPU growth instead. Facebook's heavy investments into expanding its ecosystem have also eaten into its bottom line. Last quarter, costs and expenses soared 83% year-over-year to $2.6 billion, causing its net income to slip 20% to $512 million.
However, investors should remember that Facebook's ecosystem already extends far beyond its News Feed. Facebook also owns WhatsApp, which has 800 million MAUs, and Instagram, which had 300 million MAUs at the end of 2014. WhatsApp relies on nominal $1 annual fees, but unlike Facebook or Instagram, it isn't banned in China. This gives it a possible backdoor into the massive Chinese market.
Citigroup analysts estimate that Instagram, which Facebook bought for $1 billion in 2012, could generate $2 billion in "high-margin" revenue annually after it is fully monetized with ads. That would equal nearly 12% of Facebook's projected 2015 revenues.
Facebook is also evolving its stand-alone Messenger app, which can already be used for peer-to-peer payments, into a mobile platform of its own. This could eventually generate additional revenue from sponsored accounts, sticker sales, and e-commerce integration with third-party sites.
Facebook also recently expanded into LinkedIn's backyard with "Facebook at Work," which lets businesses create their own social networks. Facebook's Oculus VR could also launch its long-awaited Rift VR headset later this year, and the company is launching Internet.org in new markets to tether more developing market users to its ecosystem.
Those are all lucrative long-term opportunities, but Facebook also faces four near-term threats. First, a strong dollar could weigh down Facebook's top and bottom line over the next few quarters. Second, Facebook faces ongoing questions about privacy in the EU, which could lead to a damaging probe of its business strategies.
Third, data breaches could eventually turn hacked Facebook accounts into "skeleton keys" for SSO connected apps and websites. Lastly, the rise of ad-blocking extensions like Facebook AdBlock could reduce the profitability of Facebook ads. According to research firm PageFair, a similar extension, AdBlock Plus, cost Google $887 million in potential ad revenues in 2012.
In my opinion, Facebook's strengths and opportunities outweigh its weaknesses and threats. It's the world's largest social network, it's profitable, and its ecosystem is growing in multiple directions. Facebook stock isn't fundamentally cheap at 30 times forward earnings, but it's still cheaper than shares of LinkedIn and Twitter, which have respective forward P/E ratios of 59 and 55.