Facebook’s second quarter earnings were a blowout.
In my last blog post on February 3, 2013 (here) I was hoping FB would trade down to EBV+5 – the $20 level – where I believed investors/traders would be presented with a good buying opportunity. Facebook traded down to a low of $22.67 on June 6, 2013 then started to trend upward to a little over $26 a share before FB’s second quarter earnings release. Subsequent to its earnings release FB shares blasted through EBV+6 and is trading around its IPO price of approximately $38 a share.
Model Price Chart
Facebook Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)
It has been over a year since Facebook has been a public company and over this period of time it has been a rough ride for the company. The birthing process from a private company to public entity has been a trail by fire with initial public investors, those who paid $38 a share, facing losses and probably tarnishing the Facebook brand in the eyes of many. The big issue the company faced and the market demanded was the shifting of its presence from the web-based PC platform to mobile. Facebook announced in their recent second quarter conference call that mobile-based active users, in just two years, exceed 100 million users much to the cheer of market participants.
However as you come to expect from this blog, let’s go a couple of steps further in terms of analysis – Model Price analysis.
I pulled from our database the usual charts. The first looking at our theoretical earnings (TE) calculation versus the published 12-month forecast of earnings per share (EPS) of Facebook.
For simplicity sake, I chart the ratio of the two lines in my second chart below.
From looking at the data, I can see why the market is very pleased with Facebook. When the differential between TE and forward-looking earnings per share are increasing the market will add valuation – recognizing Facebook’s improving fundamentals.
But isn’t our calculation of model price below where the stock is trading?
Yes it is. But look at the dynamic of our model price history over the last six months. Our model price line has increased substantially especially over the last month. (see chart above) The market, through Facebook’s share price and valuation, is anticipating substantially better earnings in the future than what analysts are currently projecting. This is what happens with very strong growth companies, market participants anticipate ever increasing earnings per share growth in the coming quarters. In other words our model price calculation will be substantially higher as equity analysis further adjust earnings upward as new and hopefully increased earnings are forecasted.
If the market is disappointed anytime in the future market participants should expect a violent correction in that excess valuation is taken away from the company as bullish expectations are readjusted.
Since the IPO, Facebook has face many challenges and disappointments. As at the writing FB is now trading in line with its IPO price and the mobile platform switchover seems to be underway. Facebook’s baptism hijinks seem to have settled down and the fundamentals seem to indicate a stable environment of substantial earnings growth with stable to slowly upward growth in theoretical earnings.
Investors who are nervous about Facebook and its progress can wait for the positive transit of EBV+7 or $41.52. If this positive transit were to occur before the third quarter results, this will be a market signal that good news will probably be announced.