Facebook Stocks is Not a Buy (2017 Update)

Are Facebook Stocks a Buy?
Are Facebook Stocks a Buy?

The Analysis Methodology

Over the years I have honed my stock picking methodology to focus on nine key factors that drive long-term stock performance.  As investors, we can get caught up in “paralysis by analysis” which means we may never act on any stock buys due to the overwhelming amount of information available about a company.

I have found that the nine factors I use to analysis stocks provides me with just enough information to make an informed decision on whether I should buy the stock or not.  At the end of the day, I want to only buy the best stocks with the best chance of generating returns greater than the market.

The following nine hurdles are the ones that I have had the most success with over the years.  I will list them below, and then analyze Facebook (FB) to determine if it warrants an investment today.

  1. Earnings per share in the latest quarter should be up at least 25% versus the same quarter last year
  2. Annual earnings for the last two years should be increasing at a rate of 25% per year or more
  3. Sales should be up 25% or more in the past two years
  4. The most recent annual gross margin should be close to its all time high
  5. Return on equity (ROE) should be 15% – 17%
  6. Stock should be performing better than the market from a price growth perspective
  7. Facebook stock should be ranked in the top 3 companies in its group
  8. The stock should have strong institutional ownership
  9. The market is in an uptrend

Analyzing Facebook (FB) Using the 9 Rules

To determine if Facebook is a stock worth considering today, let’s analyze it according to the nine rules identified above.

 

1.     Earnings per share in the latest quarter should be up at least 25% versus the same quarter last year

A lot of technology companies have been getting a pass on solid and consistent earnings when factoring in the price to buy a stock at.  Investors seem to want to buy the stock on the anticipation that it will continue to attract users which will allow the company to perform better over time.

However, as most experienced investors know, earnings growth is crucial to continued share price appreciation.  Has Facebook achieved at least a 25% EPS growth rate in the most recent quarter?

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The table above shows that when comparing last year’s Q2 EPS with this year’s, the company has achieved a growth rate of 184%.  That stock has crushed the 25% growth rate we were looking for, which is very positive.

In addition, as an additional test when comparing Q1 EPS results, the company posted 189% growth year over year.  Solid EPS results from Facebook here.

 

2.     Annual earnings for the last two years should be increasing at a rate of 25% per year or more

The second test is seeing how the company is doing on earnings growth over the past two years.  In the chart below, you can see that the growth rate in 2015 was only 17% while in 2014 the company saw an 83% increase.  Technically the stock does not pass this hurdle since the both years should have growth of > 25%.

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3.     Sales should be up 25% or more in the past two years

The sales hurdle is the next test for Facebook.  In this test I want to make sure that sales are accelerating in the most recent quarter. Let’s have a look at the sales growth rate for the past two years.

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Facebook has done a good job of increasing sales over the past two years.  It is important to note that the growth rate did drop between 2014 and 2015, however the growth rate is significantly higher than the 25% hurdle rate I have set so I am willing to allow that.  I will be watching the 2016 results closely to see if they reverse the trend to higher sales growth.

 

4.     The most recent annual gross margin should be close to its all time high

A strong gross margin indicates that a company is creating value on incremental sales.  The higher the percentage, the more the company keeps on each dollar of sales to pay for its other costs.  I like to see that the gross margin is close to its all time high, as that indicates the company is managing its costs well against revenue.  Here is the trend for Facebook’s gross revenue.

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It is clear to see that Facebook has been performing well on a gross margin basis.  Since going public in 2010, the company achieved all time high gross margins in 2015.

 

5.     Return on equity (ROE) should be 15% – 17%

Every stock I invest in MUST generate a strong return on shareholders’ equity.  I want to make sure that the management team is maximizing profitability, assets, and financial leverage.  If they are balancing these factors properly, stock returns tend to go up over time.

The hurdle for an investment into a company is an ROE of > 15%.  As of this writing, Facebook has an ROE of 14.38%, which is slightly below the 15% benchmark.  In other words, Facebook can be doing a better job of running the company.

 

6.     Stock should be performing better than the market from a price growth perspective

As an investor, I am taking on additional risk by buying individual stocks.  Over time, it is important that the individual stocks I buy beat the market returns.  Otherwise, it would be much easier to simply buy the market (i.e. SPY).

Here is a stock chart that shows that Facebook has done much better than the S&P 500 (SPY) over the past two years.  SPY is the green line and FB is the red/green candle chart.

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7.     Facebook stock should be ranked in the top 3 companies in its group

This metric can be a tough one to figure out, but I have found a great way to determine how a company compares to others in its group.  By using the stock quotes feature at Investors.com, you can see how they rank the company in terms of “Group Leadership”.

Facebook is the #1 stock in its group – Internet-Content companies.  That highlights that Facebook is performing better than all other stocks in the group.  It is always best to own the best!

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8.     The stock should have strong institutional ownership

Institutional ownership refers to the percentage of the stock’s shares that are owned by large institutions like pension funds, endowment funds or mutual funds.  Strong institutional ownership signals that these massive money management firms are believers in the company and they tend to push the share prices higher.

I like to see institutional ownership of at least 60% for a company.  In the chart below you can see that institutions and mutual funds own over 90% of Facebook.  That is a strong endorsement for the prospects of the company.

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9.     The market is in an uptrend

Finally, before I make any stock purchases I look for what the overall market is doing.  Although I am a long-term investor, I don’t like to buy stocks when the market is in a general downtrend.  Why buy now only to see the stock get taken down by a down trending market?

My metric for determining a market uptrend is simply where the SPY is in relation to it’s 10-month simple moving average (SMA).  If SPY is above the 10-month SMA, then I will buy stocks.  If it is below the 10-month SMA then I am very cautious and typically wait to add any additional money to the market.

As of this writing, the SPY is above its 10-month moving average as seen by the yellow line on the chart below.  That indicates that the market is in an uptrend and it is ok to add money to the market.

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Does Facebook Pass the Test?

So what does this analysis of Facebook tell me.  Here is a summary of each hurdle and whether the stock passed or fail:

CriteriaPass/Fail
Earnings per share in the latest quarter should be up at least 25% versus the same quarter last year.Pass
Annual earnings for the last two years should be increasing at a rate of 25% per year or moreFail
Sales should be up 25% or more in the past two yearsPass
The most recent annual gross margin should be close to its all time highPass
Return on equity (ROE) should be 15% – 17%Fail
Stock should be performing better than the market from a price growth perspectivePass
Facebook stock should be ranked in the top 3 companies in its groupPass
Stock should have strong institutional ownershipPass
The market is in an uptrendPass
Total Score7/9 Pass

 

The company does not do too bad, however in a world where it is easy to buy the market and capture the market returns I am very picky about which individual stocks I purchase.

With a failure by Facebook to obtain annual EPS growth rates greater than 25% and a lower ROE than I am comfortable with, I will be waiting to see how management performs over the next few quarters to make a decision.  Getting the EPS growth rate up plus managing the company’s profitability, assets, and leverage better (i.e. ROE) will go a long way to increase my confidence that the stock will continue to beat the market.


Despite Facebook stocks not being a buy (in our opinion), there are so many other stocks in the market which is! Start your investment today. After the new regulations being 100 shares per lot, it is much affordable for people now. If you lack the money to do so, you can approach a licensed money lender! We are able to approve your loan application, process it and pass you the cash all under an hour.

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