The Earnings Dip in Facebook Stock Is a Golden Buying Opportunity

Facebook (NASDAQ:FB) stock dropped sharply in late October after the social media giant reported third-quarter numbers that smashed user, revenue and profit expectations, broadly underscored a rapid recovery in ad spending trends and included a healthy fourth quarter guide.

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What gives?

Widespread market irrationality.

The market freaked out on the last trading day of October as a plethora of headwinds converged all at once. There were a few weak headline earnings reports. Covid-19 cases surged globally. Europe reimplemented partial lockdowns. Stimulus talks in Washington got called off. Investors got jittery about next week’s election.

All of that bad stuff came together at once, and stocks fell off a cliff. FB stock was not spared in carnage. Shares dipped about 7%.

But what does any of that stuff have to do with Facebook’s core social media and digital advertising business? Nothing.

So buy this irrational dip in FB stock. Facebook’s earnings were very good, the outlook remains very strong, and the stock remains very undervalued. Over the next 12 months, this stock will materially outperform.

Facebook’s Strong Earnings

From head to toe, Facebook’s third-quarter earnings report was very, very good.

The company sustained robust user growth in the quarter, growing both daily active and monthly active users by ~12% year-over-year, consistent with last quarter’s growth rates and broadly indicative of the reality that Facebook, Instagram, WhatsApp and Messenger collectively remain the ubiquitous social and communication backbones of our increasingly digitally connected society.

Revenue growth trends rebounded meaningfully in the quarter, with revenues rising 22% year-over-year. Revenue growth rates have now come full circle and are back to where they were in the fourth quarter of 2019 before the pandemic emerged. Of course, the takeaway is that the economy has recovered and brands are advertising again, with a heavier-than-ever emphasis on digital ad spending. Strong revenue numbers from Snap (NYSE:SNAP) and Pinterest (NYSE:PINS) corroborate this takeaway.

Sure, operating margins dipped, the U.S. and Canada user base shrunk marginally quarter-over-quarter and the newly issued 2021 expense guide is pretty hefty (management is calling for expenses to rise north of 30% next year). But the margin dip was only four points, and consistent with historical trends.

The user base shrinkage in U.S. and Canada isn’t shocking because the platform has over 250 million monthly users in that geography (meaning that almost everyone with an internet connection in the U.S. and Canada is in the Facebook ecosystem). At that level of ubiquity, some reduced usage quarter-over-quarter as the world opened back up is totally expected and nothing worrisome.

And the hefty expense guide simply tells us that Facebook isn’t done growing. Historically, this is a management team that has spent big to grow big, and whenever expenses go up a ton, revenues usually go up a ton shortly thereafter. So, given that track record, big expense growth in 2021 could actually be viewed as a positive for 2022/23 revenue growth.

All in all, Facebook’s earnings were very strong, and the post-earnings selloff in FB stock just doesn’t add up.

Macro Headwinds are Meaningless

Of course, the ostensible rationale for Facebook stock’s post-earnings plunge is the confluence of macro headwinds we talked about above.

But if you break down those headwinds, none of them spell bad news for Facebook.

Surging Covid-19 cases? If the surge does lead to a new wave of global lockdowns, Facebook usage will go up over the next few months, while ad revenue growth trends will remain on an upswing since we’ve increasingly learned how to sustain economic normalcy while quarantining.

Stalled stimulus talks? A political move. Come Tuesday, the election will be over. We will have a president locked in for four years. That president will immediately get to work on crafting new stimulus for the American people. Regardless of who wins, a big package is likely before the end of the year.

Election nerves? Whoever wins, Facebook will be just fine. Biden may be harder than Trump on Facebook and big tech companies. But that talk won’t translate to much walk, because at the end of day, antitrust action in the U.S. has historically only kicked in when companies are hurting the consumer — and as a combined company, Facebook has more resources and know-how to safeguard consumer data and privacy than if its platforms were separated from each other.

All in all, these headwinds dragging down FB stock are both transient and overstated. Facebook’s core fundamental strengths — the digital backbone of society, with an expanding lead in the burgeoning digital ad market — are not.

So buy the dip in FB stock.

Facebook Stock is Undervalued

Facebook’s blockbuster third quarter earnings report gives me greater confidence than ever in my long-term outlook for Facebook, which centers around the idea that the company will leverage its favorable competitive positioning in the booming digital ad market to drive ~20% revenue growth over the next few years.

As such, I remain confident that Facebook is on track to do at least $20 in earnings per share by 2025.

Based on a 20X forward earnings multiple and an 8.5% annual discount rate, that implies a 2021 price target for FB stock of nearly $315.

Thus, down here at $260, Facebook stock is woefully undervalued with significant upside potential over the next 12-plus months.

Bottom Line on FB Stock

Facebook stock is a long-term winner that’s being knocked down by transient headwinds.

Ignore those headwinds. Focus on the enduring fundamentals. And buy the dip in FB stock.