How to trade off the performance of Facebook

The social media darling, Facebook, has matured in recent years, now having a market cap of over $500 billion. Since its IPO in 2012, its price has gone up steadily, with only a few small lapses.

The early post IPO days of Facebook harked back to the massive busts of the dot com era, where huge multiples were given to companies with little or no sales. Facebook managed to cleverly navigate this and began to generate serious profits.

However, for the everyday man, its main success and key driver lies in its continued dedication to putting out a market leading product, allowing the site to evolve with its users to the point where it is a necessary part of social life for many people.

Based on the penetration of Facebook into public consciousness, it would be easy to assume that the company is strong. But that does not always hold true, Twitter being the most recent example.

In social media, visibility does not always translate into strong business returns. So, when analyzing the stock for value, we need to look at the relevant value metrics to decide how to trade Facebook.

Management

Although this aspect is often not accounted for in technology stocks, it is critical. For proof, think back to the impact that Steve Jobs had on the Apple stock price, or how Microsoft fared after the move from Bill Gates to Steve Ballmer.

In the technology space, it is imperative to combine both with a future focused tech visionary. And Facebook has always had that in Mark Zuckerberg.

Facebook was one of the pioneers of strategic acquisitions, acquiring potential competitors and bringing their synergistic services under their wing. The purchase of WhatsApp and Instagram are clearly complementary pieces to the Facebook platform, and each have a strong independent user base.

Whilst other metrics will ultimately show the value of the management team, the above points demonstrate that the team led by Zuckerberg and Sandberg have managed to effectively monetize the appeal of Facebook, expertly navigating the challenges that have sidelined so many others.

Revenue and Liabilities

The lifeblood of any business, Facebook has moved from revenue of $731 million in its first quarter to in excess of $8 billion per quarter. Revenue is only one financial indicator, but one that shows the amount of cash coming in.

To fully understand the picture, it is important to view the revenue through the prism of outgoings and debt, but even that is wonderfully strong, as the company holds no debt. Plump operating profits have increased in the last 2 years at a healthy 45% and 38% respectively. There is no question that Facebook is very strong financially.

User Growth

What was once the main aspect for a technology company, in Facebook’s case it is almost an afterthought. However, it’s the access to users that drives advertising revenue, data and many other elements and was a key reason for the acquisition of WhatsApp.

User growth over the last few years has steadily increased, with Facebook currently having 2 billion monthly users. User engagement is also increasing from 63% daily users to 66% daily users.

The metrics for earnings per share, ROE, ROIC, etc are all very healthy, so whichever way you slice it, Facebook is a great company with a market leading product and great financials and fundamentals.

The challenge for trading a company like Facebook is that often the multiples make it overvalued, as witnessed by its P/E ratio of 41.

The best opportunities lie in short term pullbacks in the stock price, where bad news or missed targets cause a share price drop that pull the stock back to a more reasonable value.

This is likely to be short lived as there are plenty of traders who will pounce on any short term weakness in the stock, so you need to be quick in this situation.

Because of the high cost and strong long term fundamentals, it is a good buy and hold candidate. It is also good for short term trading as well, but the lack of price fluctuation might make it difficult to make a big profit.