Facebook (FB) stock debuted less than six years ago at $38 per share and went through two very distinct sentiment shifts. The current environment, as the company faces pressure from multiple sides to better control use of its massive platform, could very well mark yet another shift.
In May 2012, Facebook IPO’d and flooded the market with stock, so much so that anyone could buy shares at the offer price. Investors were skittish that the company could move quickly to capitalize on the move from desktop to mobile usage and the stock quickly fell into the teens. That turned out to be one of the best growth stock investment opportunities in recent memory, because back then very few people understood just how much money the company would earn in just a few short years.
For instance, what if you knew that Facebook would grow revenue from $5 billion in 2012 to $27.6 billion by 2016, and that free cash flow would go from negative to $4 per share that year? Well, the stock probably never would have traded under $20 and I would bet that investors would have gobbled up every IPO share they could at $38 each.
That was very reminiscent of the Google IPO, which many people thought was wildly overpriced, only to be shocked a few years later when the company’s profits made the IPO price look like an enormous bargain (in hindsight only, of course).
As a result of huge profit growth, sentiment in Facebook has shifted dramatically in recent years and the stock had surged to $176 per share by the end of 2017, as free cash flow reached nearly $6 per share last year. While not overpriced necessarily, the bar has certainly been reset quite high, and therefore Facebook is more susceptible to near-term problems, such as how they are controlling the use of their user data and advertising platform.
The chart above shows the entire history of Facebook’s public stock performance and therefore the recent decline barely registers as a blip. If we look at the last year, we see that the shares have largely been moving sideways, and the recent drop is only about 15% from the highs:
So are the shares getting close to an attractive level? It likely depends on two factors; what valuation methodology you use, and whether you think the company can continue to grow per-share cash flow, or if future growth will be hampered by user base maturation and increased costs associated with policing the platform more heavily.
My base case is that they grow, but at materially slower rates, and margins come down some but remain quite high. As far as valuation, I prefer to use free cash flow per share, but I deduct non-cash, stock-based compensation. That metric for 2017 came out to roughly $4.65 per share (versus $5.91 if you ignore SBC). My estimate for 2018 is roughly $6.50 per share, but I realize there is risk in this figure because we really don’t know how much expenses are going to increase in the face of current political and social pressures.
For Facebook to get into the sweet spot as a GARP (growth at a reasonable price) investment, I would have to see a multiple of 20-25x free cash flow less stock-based compensation. On my 2018 estimates, it equates to $131-$164 per share. The current quote, after a 5% drop today, is $163 per share. In other words, FB stock is arguably now finding itself in GARP territory.
Given that near-term sentiment could very well accelerate to the downside, and considering that modeling 2018 growth rates of 35% in both revenue and free cash flow (the current consensus) are probably skewed to the aggressive end of the spectrum, I would probably want to pay less than the current price. However, if the stock reaches the midpoint of my 2018 range ($150-ish), it could very well make for a strong GARP investment from my vantage point.
Full Disclosure: No position in FB at the time of writing, but positions may change at any time