Facebook: Profit-taking time

Its last earnings report made the social media giant a darling of investors and analysts, but this earnings season isn't likely to be as kind.

By StreetAuthority Sep 27, 2013 5:07PM
The By David Sterman

We're heading into earnings season, which always yields some great trading opportunities.

The key is to evaluate current investor and analyst sentiment on a given stock, and to identify situations in which a company can deliver significant upside or downside relative to the consensus views.

In the case of social media giant Facebook (FB), this strategy was laid out on a platter for investors.

Heading into the second-quarter earnings release, the social media giant was universally disliked, trading near 52-week lows. But management had only recently been telling analysts that key business trends were starting to look a lot better. Most analysts were still hesitant to stick their necks out and recommend an unpopular stock.

I laid out the bull case in early July, and shares have more than doubled -- in less than three months.

In that time, Facebook has added more than $60 billion in market value. It's hard to remember the last time such shareholder wealth was created in such a short time.

The pivot
As we head into Facebook's upcoming third-quarter report (slated for Oct. 21), the entire investment thesis has flipped. Facebook is now universally loved, highlighted by rapid-fire analyst upgrades, which paradoxically makes this a great time to take profits.

In basic terms, there is little Facebook can do in terms of delivering upside relative to third-quarter forecasts (and the forward outlook). And the company's valuation is now in nosebleed territory.

The first issue to focus on is forward estimates. Facebook beat the second-quarter EPS (earnings per share) consensus by a nickel, earning $0.19 a share. Analysts used that result and management guidance to boost their full-year EPS outlook by 15 cents, to $0.72 a share. The 2014 EPS view was boosted by a similar amount to $0.96 a share.

Facebook is likely positioned to at least meet those revised forecasts, but the element of surprise is gone. Prior to the most recent quarter, Facebook typically topped profit forecasts by a penny or two, and if that happens, momentum investors may see the lack of huge upside as a disappointment.

The upgrade cycle
Though shares of Facebook received an initial solid pop when results were released in late July, the stock has gone on to climb steadily throughout August and September as well as formerly skeptical analysts have hopped on the upgrade bandwagon. The cycle played out yet again on Tuesday, when Citigroup raised its price target from $32 to $55, leading the stock to a fresh all-time high near $50.

Citigroup's new "buy" rating is based on a view that shouldn't be ignored: "Following several conversations with advertisers and agencies we believe the factors driving the sudden inflection and growth in (the second quarter) are sustainable and that there are a number of factors that should contribute to further growth and gains."

There's no quibbling with that view. It's why shares of Facebook were such a bargain three months ago. But what really changed? Citigroup calls the second-quarter results an "inflection point," but Facebook's now more robust growth path is simply the result of steps management had been taking in prior quarters. It's not as if the company woke up in recent days and went about its business differently.

Again, Wall Street's positive perception of Facebook is what has really changed, and now there is a real risk that analysts (and investors) are loving this stock too much. To get a sense of that, you need only look at this company's valuations.

Facebook's lush valuations
To be sure, Facebook appears poised for considerable growth in 2014 and 2015. But investors shouldn't extrapolate that view into perpetuity. Indeed by 2016, this business will likely be so large that robust growth is no longer feasible.

Though it's hard to pin down 2016 forecasts at this point, simply looking at 2015 projections highlights how expensive this stock is. Facebook surely deserves a market value (and enterprise value) in excess of $100 billion, but how much higher will this stock climb if free cash flow will only be in the $2 billion to $3 billion range by 2015?

It's crucial that you avoid comparing this company to Google (GOOG) and Amazon.com (AMZN). Those firms have also done a remarkable job of tapping into new growth niches -- but for a decade or longer. Facebook is wisely tapping into its own growth potential, but there must be limits to how much a social media site can be monetized.

In their move to upgrade their rating on Facebook, Citigroup's analysts laid out a host of future catalysts that will fuel growth in 2014 and 2015. Those catalysts are exactly the ones I laid out in my bullish recommendation three months ago. It would appear that such "catalysts" have already been incorporated into the share price, as these lofty multiples noted in the table above highlight.

Risks to consider:
As an upside risk, Facebook may look to pull off other acquisitions in light of the apparent success that its Instagram deal is generating. That said, there are few large targets that could really move the needle.

Action to take: Facebook is clearly riding herd with other strong gainers such as LinkedIn (LNKD) and Priceline.com (PCLN). LinkedIn trades for 51 times Citigroup's 2014 EBITDA (earnings before interest, taxes, depreciation and amortization) forecast, which is pretty astounding in its own right. Google, on the other hand, trades for less than 11 times projected 2014 EBITDA -- closer to reality.

Taken together, Facebook, Priceline and LinkedIn now sport a collective $200 billion market value, even as those firms are expected to generate a combined $16 billion in revenue this year. These are great companies, but as investors increasingly focus all of their funds on these winning trades, the companies are being loved too much. Facebook, in particular, looks poised for a reality check as we head into the next earnings season.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

More from StreetAuthority
Sep 27, 2013 11:34PM

I have to wonder how the heck Facebook ever hit $50 a share. Their only product is the verbal promise that they are going to sell loads of advertising. That business model may be working today but what about tomorrow?


The company has very little in terms of actual assets, just the word of their marketing folks that they are rolling in ad dollars.


Facebook and other social media sites are becoming boring, well they were always boring but now people are starting to see that more.


I would invest in just about anything before I's buy a single share of this hyper-smoke screen company.

Sep 27, 2013 7:50PM
America got it right at the IPO... those who bought in... lost. It was revived by QE funds, just like every dead cat in the markets. Facebook is a counterproductive pariah hurting America. Shut it down along with Twitter and Linked-In. If you want cliques... relocate. They're un-American and the majority of us aren't interested in global anything.
Sep 29, 2013 10:17AM
when the inside traders take their money out the rest of the poor bastards will be left holding an empty bag. 
Sep 28, 2013 11:36AM
the sp will be kept high untill all the insiders/smart money have bailed.
Sep 27, 2013 10:01PM


Sterman is taking over for Anthony M. with the charts, but still just a pump and dump snake oil salesman.  How many shares is he trying to unload?


I've sent my complaint to the SEC about this slime ball and referenced MSN too.  Doesn't matter, with budget cuts everybody at the SEC lost their jobs.


Maybe I'm wrong.  Perhaps it is somebody's job to separate chumps from their money.  After all, America invented CARNEY!!!!!!!


Correct me if I'm wrong.  Pump and dump is against the law?





Sep 28, 2013 7:41AM
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