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Investors Are Heavily Discounting Google, Facebook's Growth Prospects, Says KeyBanc

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Investors Are Heavily Discounting Google, Facebook's Growth Prospects, Says KeyBanc
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Facebook Inc (NASDAQ: FB) and Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL) are each higher by more than 35 percent over the past year, which begs the question: what level of growth is already priced into the stock today? 

The Analyst

KeyBanc Capital Markets' Andy Hargreaves maintains an Overweight rating on Facebook's stock with an unchanged $245 price target and an Overweight rating on Alphabet's stock with an unchanged $1,280 price target.

The Thesis

Hargreaves oversaw an analysis of U.S.-listed companies with market caps of at least $1 billion, excluding utilities, materials and energy. One of the screens looked at expectations of growth and another screen focused on valuations, Hargreaves said. 

The 200 companies trading between a 15x EV/EBITDA multiple and 25x EV/EBITDA multiple have an expected two-year compounded annual growth rate of 11 percent, the analyst said. At Facebook, that figure is 26 percent and at Alphabet, 16 percent.

Investors are modeling Facebook to miss its consensus annual growth expectations by 15 basis points over two years and are modeling that Alphabet will similarly fall short by 5 basis points, Hargreaves said. 

"This is extremely unlikely, in our view, as both companies retain extraordinary momentum in their core businesses and have strong powerful new growth drivers." 

KeyBanc's deep dive found that investors are pricing in margin compression to "neutralize" revenue growth at both Facebook and Alphabet, Hargreaves said. While there may be some logic behind this thinking — especially at Facebook — the magnitude of margin compression that would be needed to neutralize revenue growth at both companies "appears highly unlikely," the analyst said. 

Related Link: Survey: Young Users Unfriending Facebook

'Irrational Fear' At Play? 

The gap between Facebook and Alphabet's growth-to-value ratios and the market's valuation could imply that qualitative factors like concerning news headlines are to blame, the analyst said. In other words, investors are "pricing in an external shock" that could drastically impact the long-term profit potential at both companies.

For example, antitrust laws are a source of concern for investors, but in the U.S., any changes to existing laws would likely require a complete revamp of existing legislation, Hargreaves said. Today's laws are focused on consumer welfare and abusive pricing, and this does not impact Alphabet and Facebook, he said.

In Europe, antitrust concerns are similarly overblown, as both companies could tackle any changes in laws through breakups or limitations on future acquisitions, Hargreaves said. 

"We believe this provides an opportunity to purchase above-average growth at Facebook and Alphabet for a price that is well below average," he said. "We suggest investors take advantage of this and buy Facebook and Alphabet."

Price Action

Facebook was up 0.91 percent late in Monday's trading session, while Alphabet was up 1.17 percent. 

Related Link:

A Look Into The Antitrust Environment Surrounding Internet Giants

Latest Ratings for FB

DateFirmActionFromTo
Oct 2018CitigroupMaintainsBuyBuy
Oct 2018Morgan StanleyMaintainsOverweightOverweight
Oct 2018Credit SuisseMaintainsOutperformOutperform

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