Facebook: The Crowd Is Fearful – Facebook, Inc. (NASDAQ:FB) No ratings yet.

Investment Thesis

Facebook (FB) has been a strong performer over the past twelve months. It has worked hard to put behind its troubles and has laid out a vision on how it can improve its operations and successfully execute over the medium term, which I contend investors are not fully appreciating.

Consequently, I argue that Facebook is meaningfully undervalued and that it will be a strong performer over the next 18 to 24 months.


Questions Of Growth

There is no question that Facebook historically has posted astonishing growth rates. Even up to a couple of years ago, it was an unstoppable growth machine.

The problem right now is, although investors have come to terms with the fact that Facebook is maturing, the question on every analyst’s mind is: just what sort of growth rate will Facebook stably have going forward?

Source: author’s calculations

We know that the tail end of 2018 and all of 2019 are being operated as ‘reset’ years. The key premise is whether Facebook will over the next two to three years continue to grow its revenues at above 20%?

And I staunchly believe that CEO Mark Zuckerberg and the rest of his team have not all of suddenly given up on their competitive edge and decided to call it a day.

Admittedly, Facebook is highly unlikely to ever again post anywhere near 50% growth rates again, but looking squarely at the rest of FAANG(+M) group, and neither are the rest of them going to be posting this level of growth either. These tech juggernauts are maturing. The question now boils down to which ones are underpriced relative to investors’ expectations? And which one we should clearly avoid?

Why Facebook Is The Best Company

Finding the best company is very different from finding a great investment.

Finding the best company is a relatively easy feat to accomplish. One can screen a stock database with ease, and within a few minutes (at most), Facebook would surface as one of only a handful of companies which is a genuine money-making machine.

In fact, I personally do not know of any other company which is able to regularly convert revenue into free cash flow at approximately 31% (this includes Facebook’s notoriously large stock-based compensation as a cash cost).

Investing though is slightly more complicated than that because one needs to find not only the right company but, even more importantly, needs to invest at the right price. What’s more, finding the right company when everyone else knows and expects the company to have a rosy outlook will not deliver an investor a meaningful return.

The game ultimately boils down to having the conviction of looking at an investment differently than everyone else and being right. Because looking at things differently to others in and of itself is hardly enough. One has to be contrarian and correct.

Valuation – Large Margin Of Safety

Source: author’s calculations

The above table is a reminder that Facebook has fallen from grace. On both a P/Cash Flow (from operations) and a P/Sales metric, there is no question that Facebook presently trades at a discount to its historical valuation.

And there are good reasons for this. Firstly, Facebook’s growth rates are slowing down.

Secondly, and equally weighty, Facebook is facing strong headwinds in the way that it executes its operations. Public outcry with regards to privacy concern is not going away anytime soon. Even if Facebook has the war chest to stomach this $5 billion FTC fine, the next time around, the fine could be even more damaging, and Facebook does not want to have to go through this again anytime soon.

The Bottom Line

Within the large-cap universe, Facebook stands head and shoulders above the rest. Not only does it continue to plow forward at an unstoppable growth rate but also continues to gush out free cash flows.

With the exception of the small amounts of capital used for share repurchases, most of Facebook’s cash flows end up on its balance sheet. In fact, roughly 9% of Facebook’s market cap is made up cash, which at some point will be returned to shareholders.

Ultimately, it is difficult to argue that at present Facebook is not undervalued.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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