My current portfolio. Updated March 2021
There’s a lot of negative news about Facebook of late. The latest is the “pay to link news” law happening in Australia. Benedict Evans has an excellent write up about it which I recommend reading.
This is coming after news of Apple issuing prompts to users on iOS14 which will reduce FB’s ability to track user behaviour across apps. This is worrying because the success of Facebook’s Ad tools lies in the ability to accurately show relevant ads. We won’t know how this impacts FB’s revenue until next quarter. Something to bear in mind.
The market is clearly pricing in the negative news, particularly the iOS14 privacy update. Facebook is trading at around 11x 2020’s gross profit and about 8.5x 2020’s revenue. For reference, FB used to trade at 15x revenue in 2016.
Past performance is not an indicator of future performance, so let’s assume FB will continue trading at the multiple it’s trading at. Let’s look at the raw business performance :
Revenue : grew 100% between 2017-2020 (year on year average is about 22%).
Gross Profit Margin : 80% (average over 5 years).
Monetisable active users grew 12% a year.
Assuming Revenue continues growing 20% and the multiple of 8x contracts to 4x, Facebook’s 2021 market cap could shrink to $412bn. This is roughly a 45% decline. Is this scenario possible? I don’t know.
It all depends on how the next quarter goes. If FB shrugs off the iOS14 revenue threat and continues expanding, the market could give it a new revenue multiple of 10x, taking the market cap to $859bn. That’s a 16% gain from today’s price while still being less than the multiple between 2013-2018.
What I think about Facebook
Facebook is a fabulous business. It’s a $700+bn market cap company making north of $80bn in revenue, $69bn in gross profit and $20.9bn in Net Income. It is growing north of 20% a year and makes 80% gross margin.
Very few companies of this quality trade at a such a low gross profit multiple (10.6x in 2020). Amazon for reference currently trades at 15.9x gross profit.
Facebook has the difficult job of balancing advertiser’s demands as well as FB core users’ experience. Adding to this is the challenge of managing misinformation and toxic content while also fending off regulators and Apple.
As an advertiser, I am closely monitoring my ad performance throughout 2021. I do see a slight dip in performance and it might impact the way I allocate budget in the short term. This is a risk that all investors need to pay attention to.
However, the degradation in ad performance isn’t large enough for me to dramatically reduce my ad spend. If my experience aligns with most advertisers’ and I choose to reduce my ad spend on FB and allocate more to Google Ads, it is possible that next quarter’s revenue could take a 10-20% dip and the stock could devalue accordingly. However, this is speculation and I prefer not to invest based on this.
I believe in the long term, Facebook will continue attracting more advertisers and revenue will increase alongside that. I also believe the core newsfeed experience will continue to improve. Facebook has committed to making the platform less toxic and filled with less misinformation. It is in their interest to do this because Facebook relies heavily on happy users to login, scroll the feed and get served ads to.
The efforts seem to be working. The quality of my personal newsfeed is improving. I get a good mix of news from friends, from FB Groups I follow. I do get ads which are sometimes annoying (ironic since I advertise on FB), but hey, Facebook is all about ads. My personal experience may not tally with yours, so please leave a comment if you have a worse experience on FB and have discontinued use.
For now, I am happily buying Facebook shares despite the headwinds. I believe a company with such a dominant position in the “interest based ad targeting market” should be valued much higher than a mere 10.6x gross profit.
*This post is opinion and not investment advice. I am not a licensed financial advisor and merely some guy writing stuff on the internet.