Bad News Doesn’t Stick to Facebook so Invest Through the Noise

The social media giant continues to deliver despite all the negative news.
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Despite Facebook's (FB) - Get Report tumultuous year, the stock is up 43% in 2019, significantly outperforming the S&P500's 26% gain.

Rather than getting caught up on what may or may not happen with the Federal Trade Commission, investors should consider Facebook's ability to consistently navigate gray areas and still generate robust cash flow. Meanwhile, the stock is still too cheap and is a buy. Here’s why:

FTC Eyes Facebook Again

With great power comes great responsibility. Facebook is fresh off its $5 billion FTC fine earlier in the year, and the FTC is now back again. Last week, reports came out that the FTC was considering seeking an injunction to stop Facebook from integrating its family of apps.

Here, it is important to take a step back and rationally consider the impact of such a move. Facebook has a very long history of succeeding when others said it would not. But one thing we can objectively ascertain is that Facebook has always been steadfast on generating strong cash flows, and any fallout from this (potential) injunction are likely to be successfully mitigated.

For shareholders, it is not only that Facebook’s CEO Mark Zuckerberg is an extremely astute capital allocator, but it's the whole A-star team, including lawyers, which assist Facebook in being as strong as it is. Moreover, presently, investors are not being asked to pay too much for Facebook’s shares.

Next Era of Growth?

Facebook derives 98% of its total revenues from advertising. With a strong focus over its profit margins, this has allowed Facebook’s operating profit margins, even after accounting for heavy stock-based compensation, to hit approximately 31%.

Consequently, unlike other companies during this bull market, which are posting strong growth accompanied with razor-thin GAAP profit margins; for Facebook, it is not a question of whether or not it will find a path to profitability, it is more a question of just how much profit will Facebook make.

Looking ahead, Facebook has already been attempting to get some traction in its second era of growth. One area which is showing some promise is Facebook’s Pay. This is an attempt to monetize Facebook’s Marketplace, with its 800 million monthly active users. Thus far, Facebook’s payments account for a very small percentage of total revenue, but these are still very much early days.

Valuation - Large Margin Of Safety

Given that nearly all of Facebook’s revenues are from advertising, it’s logical to value Facebook with other social media platforms. But in time, as Facebook’s payments start to become a significant portion of its revenue, investors would be wise to start to compare Facebook with PayPal (PYPL) - Get Report and Square (SQ) - Get Report, and other payment solution platforms.

The most important point is that investors have a tendency to oscillate between mass pessimism and enthusiasm. And even though Facebook’s shares have rallied in 2019, there is no way a rational investor could contend that investors are being asked to overpay for Facebook. Indeed, investors are only asked to pay 16x its cash flows from operations, while Facebook is realistically still growing at north of 20% over the next two to three years.

The Bottom Line

Facebook consistently gets negative press. In the same way that a strong financial institution has to weather potential fines from time to time, so, too, does Facebook. And that’s not a significant problem, as long as Facebook’s management continues to plow ahead. 

In fact, even delivering the status quo, without any positive surprises, Facebook is a terrific investment. Further, if any positive surprises were to surface with Facebook’s payment solutions, investors would be truly well rewarded for paying today’s prices. 

Facebook is a holding in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells FB? Learn more now.