Facebook Surpasses Profit Expectations

Morningstar analysts review Facebook's latest performance statistics - but warn that they expect both profitability and the share price to fall over time

Rick Summer, CFA, CPA 18 August, 2014 | 10:17AM
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Facebook’s (FB) solid second-quarter performance surpassed our expectations for both revenue and profitability, as advertisers continue to increase spending across all geographies. After adjusting our valuation model, we anticipate increasing our fair value estimate by more than 10%, although we consider the shares modestly overvalued at these levels. While we see no catalyst for selling the shares, we are hesitant to recommend allocating new money toward an investment in Facebook. Our wide economic moat rating is unchanged.

Although we expect revenue growth to eventually fade, near-term results continue to outperform. Total quarterly revenue grew 61%, led by the advertising segment which grew 67%. Perhaps most importantly, mobile revenue grew 151% over the year-earlier figure. Without question, this company is a current mobile advertising giant, posting approximately $1.7 billion in mobile revenue for the quarter. 

In terms of profitability, the leverage in Facebook’s business model is evident. GAAP operating margins came in at 48%, above our long-term expectations. We expect Facebook to eventually -- and prudently -- invest in projects that are lower-margin, but that ultimately provide value to both advertisers and shareholders over the long-term.

We continue to model a decline in profitability over time. Still, we believe the shares today are valued at the long-term potential for the company to achieve and hold onto its position as a leading digital advertiser.

Although the revenue opportunity for Facebook is large, the company faces several risks that could ultimately prove our investment thesis to be overly optimistic. First, regulators may prevent the company from tracking its users. Significant regulatory action could detract from the value of its advertising platform. Second, excessive advertising or privacy fears could lead to a mass exodus of users.

Other social networks such as MySpace, owned by News Corporation NWS, have experienced declines. Lastly, if agencies and advertisers experience a permanent lack of visibility into advertiser return on investment, Facebook's advertising opportunity may be significantly constrained.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Meta Platforms Inc Class A607.75 USD1.32Rating

About Author

Rick Summer, CFA, CPA  Rick Summer, CFA, CPA, is a senior stock analyst with Morningstar.

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