Tuesday, January 28, 2014

Is Facebook an Attractive Investment?

With shares of Facebook (NASDAQ:FB) trading around $53, is FB an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let's analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Facebook is engaged in building social products in order to create utility for users, developers, and advertisers. People use Facebook to stay connected with their friends and family, to discover what is going on in the world around them, and to share and express what matters to them with the people they care about. Developers can use the Facebook platform to build applications and websites that integrate with Facebook to reach its global network of users, building personalized and social products. Advertisers can engage with more than 900 million monthly active users on Facebook — or subsets of its users — based on information they have chosen to share.

Last week, Princeton released a widely-cited but pretty flawed study saying that Facebook will lose 80 percent of its users between 2015 and 2017. On Thursday, Facebook responded by using Princeton's methodology to prove that Princeton will lose all of its students by 2021, and the Earth will in fact run out of air by 2060. In a Facebook post titled "Debunking Princeton," Facebook used Princeton's "correlation equals causation" idea on the university itself to show that just because Princeton says it, doesn't mean it's true. The Princeton study is flawed for several reasons. It uses a strange epidemiology metaphor likening Facebook to a virus that Facebook users will eventually "recover" from. Just because Facebook can be addicting and takes up more of our time than many people are proud of, it doesn't mean the social media site actually operates like a sickness.

T = Technicals on the Stock Chart Are Mixed

Facebook stock has been exploding to the upside in recent years. However, the stock is currently pulling back and may need time to consolidate before heading higher. Analyzing the price trend and its strength can be done using key simple moving averages. What are the key moving averages? The 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Facebook is trading above its rising key averages which signal neutral to bullish price action in the near-term.

FB

(Source: Thinkorswim)

Taking a look at the implied volatility (red) and implied volatility skew levels of Facebook options may help determine if investors are bullish, neutral, or bearish.

Implied Volatility (IV)

30-Day IV Percentile

90-Day IV Percentile

Facebook options

60.84%

93%

90%

What does this mean? This means that investors or traders are buying a very significant amount of call and put options contracts, as compared to the last 30 and 90 trading days.

Put IV Skew

Call IV Skew

February Options

Flat

Average

March Options

Flat

Average

As of today, there is an average demand from call buyers or sellers and low demand by put buyers or high demand by put sellers, all neutral to bullish over the next two months. To summarize, investors are buying a very significant amount of call and put option contracts and are leaning neutral to bullish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates and the conclusion.

E = Earnings Are Increasing Quarter-Over-Quarter

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. Also, the last four quarterly earnings announcement reactions help gauge investor sentiment on Facebook’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Facebook look like and more importantly, how did the markets like these numbers?

2013 Q3

2013 Q2

2013 Q1

2012 Q4

Earnings Growth (Y-O-Y)

108.33%

58.33%

0.00%

-89.46%

Revenue Growth (Y-O-Y)

59.75%

53.13%

37.81%

40.14%

Earnings Reaction

2.44%

29.61%

5.61%

-0.83%

Facebook has seen increasing earnings and revenue figures over the last four quarters. From these numbers, the markets have been pleased with Facebook’s recent earnings announcements.

P = Average Relative Performance Versus Peers and Sector

How has Facebook stock done relative to its peers, Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), LinkedIn (NASDAQ:LNKD), and sector?

Facebook

Microsoft

Google

LinkedIn

Sector

Year-to-Date Return

-3.62%

-3.37%

-2.15%

-4.10%

-2.31%

Facebook has been an average relative performer, year-to-date.

Conclusion

Facebook looks to provide a valuable social networking experience to its users, developers, and advertisers. Last week, Princeton released a widely-cited but pretty flawed study saying that Facebook will lose 80 percent of its users between 2015 and 2017. The stock has been exploding to the upside, but is now pulling back. Over the last four quarters, earnings and revenues have been increasing, which has left investors pleased about recent earnings announcements. Relative to its peers and sector, Facebook has been an average year-to-date performer. Look for Facebook to continue to OUTPERFORM.

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