Breaking Down A Bull's Case For Facebook

By Quint Tatro

Thursday I appeared on CNBC to take the bullish side of Facebook Inc FB. While I never advocate buying ahead of earnings I made sure to try and weave in the strategy for what I thought could happen once the stock reported a few minutes after the segment ended. Here’s a more in-depth review of what I was attempting to say within my allotted 2 minutes.

What I said – Facebook’s a winner

What it means: FB has risen over 32% in the first few months of 2017 while the S&P 500 has advanced over 6 percent and the NASDAQ is up 13%. While all of these gains are impressive, it is clear that Facebook is in demand more than other stocks in the market. One shouldn’t over complicate this and simply understand that just because it is outpacing the averages it doesn’t mean it has to stop there. Winning stocks can often outpace rivals for years and even decades. In fact, Facebook is now up more than 150% in the last 3 years, which is more than 5x that of the S&P and over 3x that of the NASDAQ. A great trading adage is to ride the winners and sell the losers.

What I said – It’s Not a Value

What it means: Often, investors will search for stocks where the price of the company is below what it may actually be worth. A classic investment style used by famous investors such as Warren Buffet is to look for these opportunities where one may be able to pick up shares ‘on the cheap.’ There are generally two major investing themes when it comes to stocks, value and growth. While value investors look for a discount, growth investors are seeking to try and buy a stock that is growing at a rate faster than the stock may be pricing in. My goal in mentioning right off the bat that Facebook was not a value is to make sure people know they are not buying something that is selling at a discount but rather a company that is still in the early growth stages of development. For this very reason Facebook should always sell for a premium to what it may actually be worth because of its future growth.

What I said – Priced to Perfection

Generally stocks will be discussed and compared against current and future earnings. When evaluating a growth company it is key to see what it is trading for in relation to its future earnings to see if investors have gotten a little ahead of themselves, or aren’t giving the company enough credit. In some instances a stock may be trading exactly in-line with its projections. For 2017 Facebook is anticipated and on track to earn approximately $5.39 per share. The anticipated earnings per share for 2018 is $6.69. Should Facebook hit these numbers this represents a growth rate in earnings per share of approximately 24%. Now that we understand the general growth rate from 2017 – 2018 we can use this as a gauge of where the company is trading in relation to its future EPS. If you take the share price of $150 divided by the 2018 anticipated EPS of $6.69 this gives the stock a forward P/E of 22. In other words the stock is trading at 22 times its 2018 earnings per share. Since the growth rate is 24 percent and the earnings multiple is 22, this is just about perfect pricing.

What I said – Investors Would Love a PullBack

The stock has been straight up and has offered very few the opportunity to buy on a dip. Smart investors rarely will chase stocks up but rather they will wait patiently for a short term drop where they may be able to snatch up a quick bargain. Count me in on this camp.

What I said – Firing on all cylinders ($30B in cash and no debt)

OK so this is a bit of hyperbole but naysayers have often talked about how Facebook doesn’t really do anything or make anything. When they first became public investors shunned the stock as it was ‘not profitable.’ Over time this company has learned how to generate amazing profits and socked $30B in cash away with no debt. This gives Mark and the crew the ability to buy other companies, reinvest in new technology and look for strategic ways to grow in the future. This is not your 1999 tech name that has run 150% with no earnings, no revenue and a mountain of debt.

What I said – Investors will be smart enough to price that in

Kelly asked about the 3,000 new engineer hires to police the content being posted. What she was alluding to is the cost of this and how this may impact those same earnings I mentioned above. For example, let’s say that those 3,000 employees all make around $100k per year (ya, lofty but maybe it buys them a 1 bedroom in Silicon Valley) This translates into a $300M per year expense. With 2.8B shares outstanding this equates  to around $0.10 per share in expenses. While this may seem like a lot, with expectations of $6.69 in 2018, it isn’t all that much and my hope is that investors can do that simple math and learn that it isn’t going to be a big drag on earnings at all.

In Summary

In summary my bullish position on Facebook is due to all of the above however, like many, I am not currently in the stock. I made a classic mistake after buying for clients at $24 and selling around $84 that I didn’t want to be a pig. Oh what a mistake that was. Now I find myself anxiously awaiting a market drop that brings Facebook with it because it is on the top of my shopping list when the dark clouds roll in.