Facebook: The Drop Is an Opportunity

It was around a month ago that Facebook (FB) released its second-quarter results. Although the company's performance was better-than-expectations, its shares have dropped almost 5% since the results came out. Now, I find it surprising to see that Facebook's shares have dropped after its earnings results as the company reported impressive growth in its key metrics.

Impressive growth across key metrics makes the drop surprising

For instance, Facebook's revenue was up almost 39% year-over-year to $4.04 billion.

In addition, the company reported second quarter non-GAAP net income of $1.4 billion, or $0.50 per share, an increase of 28% from $1.1 billion, or $0.43 per share during the same period last year. The improvement in the company's financial performance was driven by accelerated customer engagement across its collection of apps, which keep on expanding regularly within short intervals.

In fact, Facebook reported a 17% year-over-year expansion in the number of daily active users for the second quarter to 968 million on average. Daily Active Users (DAUs) for mobile had also increased 29% on a year-over-year basis to 844 million for the quarter. Further, Monthly Active Users (MAUs) had expanded 13% year-over-year for the quarter to 1.49 billion, and MAUs for mobile increased year-over-year by 23% to 1.31 billion.

Importantly, the social networking giant delivered $1.33 billion of strong free cash flow for the quarter, in line with its continued commitment to enhance shareholder's wealth. But, despite these impressive numbers, Facebook shares have dropped in the past month. However, I think that this is an opportunity in disguise for investors.

The continuously growing popularity of Facebook among the expanding number of internet users across the globe since the establishment of the company in 2004 will continue at an accelerated pace. This will happen as more users get engaged with the social networking experience offered by Facebook. As a result, in order to expand its reach, Facebook is entering into agreements with other companies.

For example, Tsinghua Holdings, a parent company of Tsinghua Unigroup Ltd., recently that it will expand its U.S. partnerships beyond just hardware to other key companies such as Microsoft and Facebook. If such a partnership materializes, it will allow Facebook with strategic access to the significantly huge Chinese market where its entry is largely blocked.

Expansion will lead to higher expenses

Facebook says that unfavorable foreign currency translations will probably lower its revenue for the current quarter by over 10% owing to the strengthening U.S. dollar. In addition, the social networking giant has reiterated that its expenditures for this year will grow by approximately 55% to 65%, which is somewhat reduction lower at the top end as compared to its earlier estimate of 55% to 70%.

As a result of these increased expenses and weakness in revenue, Facebook's margins might see some weakness in the short run. However, investors should not forget that the company is making smart moves to improve its business from a long-term perspective. This is the reason why analyst sentiment around Facebook is positive as well.

The consensus estimate among 55 polled investment analysts evaluating Facebook suggests that the company will outperform the market. This consensus rating has been maintained since the investment analysts' sentiments got better on May 29, 2012; a short time after Facebook went public. The earlier consensus estimate suggested investors to hold their position in the company, which means that analysts' sentiments have improved.

Conclusion

Finally, keeping the company's valuation in mind, I think Facebook is a good buy. The company has solid growth prospects with a PEG ratio of 1.50. However, the stock might seem expensive due to trailing P/E and forward P/E ratios of 91 and 32, respectively, as compared to the industry's average P/E of 33. But, the gap between the forward and trailing P/E ratios indicates that Facebook's earnings are expected to grow at an impressive pace in the future.

Hence, I think it will be a good idea for investors to buy Facebook shares on the drop as they can pick up pace in the long run.

Published on Aug 29, 2015
By Yaggyaseni Mittra

Copyrighted 2016. Content published with author's permission.

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