Stock of the Week - Facebook (FB)

Facebook on Fire, but Be Patient

Facebook (FB) needs no introduction. It's a social media site that outlasted Friendster and at the moment trumps Google Plus. In May of 2012, Facebook issued and sold 180 million class A shares at a price of $38 per share. However the stock spent most of its past year or so below the initial public offering price. The reason? People were skeptical that Facebook would be able to monetize their platform even with their 699M* active daily users and over 1.1B* active monthly users.

Highlight Fundamentals

Facebook's revenue is derived from two major sources. The first is advertising, whereby marketers will pay for ad product displays either on an impression basis or a cost-per-click business model. However, this does not always mean that the more impressions an ad receives the higher the revenue. Certain display ads only count the initial display as an impression regardless of how many times the ad is actually displayed within the News Feed. In general, Facebook's advertising revenue model is not unlike Google's.

The second revenue generating model is collecting fees from payment transactions done within Facebook. Facebook platform developers may develop games or programs in which users will transmit funds through Facebook. As a result, Facebook will take a fee for users using the payment infrastructure. Other revenues sources include Facebook Gifts revenue and Promoted Posts, which have been considered immaterial at this point.

ARPU (Average Revenue per User) has increased quarter over quarter

Facebook is heavily dependent on advertising revenue. This is different from our previously featured stock, whereby is not dependent on advertising revenues. For the first six months of this year, advertising made up about 87% of Facebook's revenues. In theory, the appeal of advertising with Facebook is you are able to reach a large audience. But, it's a largely general population. This means if you are a business that is looking to target consumers interested in the outdoors, chances are your ad may not hit your target audience. Historically, Facebook's revenues has been directly correlated with revenues. Meaning more users typically equaled more advertisers. The company experienced tremendous revenue growth rates from 2010 to 2011 and then 2011 to 2012 of 88% and 37% respectively. This rate is expected to decrease should Facebook not be able to find other ways of generating revenue.

Facebook's 2013 annualized comprehensive income based on 6 months ended 6/30/13 figures is $1.042B. It currently sits at a market capitalization of $115B. Comparatively, Google's annualized comprehensive income net income is about $11B. If we looked solely on revenues alone, we would expect Google to have a valuation of a trillion dollars. Of course, Google's market capitalization only sits at $300B. Either Google is grossly undervalued, I'm using the wrong metrics, or Facebook is grossly overvalued. Regardless we can't ignore the price action of the Facebook the past few weeks.

Highlight Technicals

From a technical perspective, there were two very good buying opportunities in the past six months. While you may be hesitant to play the huge gap up from the recent earnings report, that might have been your best entry point. Facebook had been "treading water" for most of 2013 and that gap up basically took out a lot of resistance levels.

If you were concerned that that the gap wouldn't hold, there was another buying opportunity at 42 when it attempted to test the 20DMA once again.

Hindsight would've told you that the 36 level was a good buying opportunity, but there is no distinct support level there. 

In order to manage risk, I would've set my stop (on the first entry) just below the gap up level and then trailed it going up. For the other entry points, the 20DMA would've been a good stop.

Right now, it's important to be patient and wait for another entry point. The stock is breaking out so I would not be surprised of if it continued higher, especially if the market goes gangbusters

Disclaimer: This article is written for informational purposes only and isn't intended as investment advice.
Disclosure: I do not have a position in FB.

* As of 6/30/13

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