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2 Reasons Why Facebook Is Still A Long

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2 Reasons Why Facebook Is Still A Long

"Imagine you could charge for lemonade without having to pay for lemons. That's Facebook. It remains one of the best businesses we've ever seen and is chronically misunderstood." -Clay Gardner, Titan Co-CEO & Chief Investment Officer

After hours Wednesday, Facebook.com, Inc. (NASDAQ: FB) fell -7% after reporting Q4 earnings.

Based on the stock price reaction, you might have imagined they missed investor expectations.  But to the contrary, we believe they performed well on nearly every metric on our checklist - all the way from user engagement to profits.

Call us contrarian, but we think Facebook remains one of the most misunderstood businesses.

So what gives with this earnings report?

Our research team of ex-hedge fund analysts at Titan believes it boils down to two things: 1) Wall Street's overreaction to a bloated headcount figure and 2) myopic focus on short-term results.

Headcount

While Facebook's 26% growth in headcount may come as a surprise at a headline level, we actually believe it makes a lot of sense given the current regulatory environment. 

The company has been signaling for several quarters that it would be increasing its investment in security and content regulation ahead of the 2020 election cycle, given the recent controversy around the company's advertising business.

We believe this headcount growth is the direct result of this and more of a conciliatory gesture to Capitol Hill vs. a structural flaw in Facebook's business model. 

In fact, one of the first things Facebook boasted on the investor call was the number of engineers it had working on those security measures. We were pleased to hear this. It signals management's continued prioritization of long-term value over short-term profits. And tellingly, despite the rapid headcount growth, the company was still able to exceed Wall Street's profit forecasts (to the order of ~60bps operating margin). 

Long-Term Value

We were generally pleased with Facebook's performance in Q4 and believe the long-term growth thesis is soundly intact. 

Reminder: Facebook has a near-monopoly on the social graph, making total users and engagement a critical metric - both exceeded analyst estimates, growing 9% and 8% year-over-year, respectively.

All the while, monetization (as measured by average revenue per user) grew a whopping 16% and 19% in the U.S. and globally, while user engagement remained ever-steady at 66%.

Zooming out, this is a business that continues to check off every item on a long-term investor's checklist: massive room to run (from digital advertising share gains), pricing power (best-in-class user engagement), high returns on capital (strong monetization trends), and the ability to hire talent (engineers).

As John Malone, billionaire chairman of Liberty Media, has said: "[Mark Zuckerberg] has the best business model that’s ever been created. [Facebook] benefits from everyone else’s content, for free."

As a long-term investor, one can only hope that the market overreacts to Facebook's earnings like it did yesterday. Wonderful businesses that are misunderstood can be the best buying opportunities.

Disclosure: We own Facebook's stock on behalf of clients at Titan. We initiated the position in February 2018.

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As of this writing, FB was a portfolio holding of Titan Invest clients. It may cease to be a holding in the future.

Image by Simon Steinberger from Pixabay

 

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