Facebook (FB) reported another blowout quarter with growth accelerating.  Strength was across the board in all geographies.  Earnings estimates for 2021 thru 2023 are moving up substantially.  If this sounds like what we wrote for Alphabet and Apple that is a fact.  You can add Amazon to the mix with a similar report.  It is the return of FANG.  All but Alphabet have seen their shares lag since last summer following a huge run up in the initial stages of the market’s recovery from the pandemic.  In hindsight, the huge gains in these stocks in 2020 were spot on.  Earnings have massively beaten consensus expectations for the past three quarters. 

More evidence is developing that the upside is not just from pulling forward growth due to the impact the pandemic had on consumer and business behavior.  Instead, there appears to be a new higher base of revenue off of which FB and other digital economy companies can sustain above average growth.  Growth will slow, particularly after the upcoming quarter that compares to a period last year when the initial lockdowns severely depressed most advertising, including online.  eCommerce got a boost almost immediately as the pandemic started so tougher comparisons begin in the current quarter. 

For FB shares, we think the setup remains favorable.  Three consecutive big earnings beats, limited upside in the shares for six months, materially higher earnings estimates, and signs that the shift toward digital economic activity has a meaningful level of permanence combine to leave upside in the stock even after the recent run and big post-earnings bounce.  Northlake thinks FB deserves to trade at premium to the S&P 500 that now has a P-E of about 20 times 2022 estimates.  It looks like FB could earn at least $15 in 2022, up 15% against a gain of 30% in 2021.  Applying a P-E of 25 on 2022 earnings estimates leaves us with a target of $375, or additional upside of 15% by year end.

Beyond the earnings results, we were most interested in the company’s comments on future growth drivers.  New large markets were noted in virtual and augmented reality, shopping, and supporting content creators.  Management noted these are incremental opportunities, while growth in the core advertising businesses of Facebook and Instagram are still quite strong with engagement holding firm so far as economies reopen and ad pricing rises strongly. 

The company provided some datapoints to support the large potential of the new initiatives.  After a slow start, the Oculus artificial and virtual reality headsets are gaining traction.  Quarterly revenue is nearing $1 billion and notably there was little sequential slowdown off the holiday quarter.  The development of an app store for AR and VR offers potential for high-margin revenue growth.  In shopping, management noted that there are over 1 billion users of the company’s Marketplace and that only 5% of the businesses that are on Facebook either pay for advertising or use the ecommerce tools.  Similarly, Facebook Watch has a huge audience but is not used by content creators in the way that YouTube monetizes.  Beyond these growth opportunities, WhatsApp and Messenger remain unmonetized despite massive usage and reach.  The importance of these early-stage growth initiatives is magnified as comparisons in the core advertising business get tougher in the remainder of 2021 and 2022.  Most importantly for FB shares, these longer-term opportunities support the growth outlook which in turn supports a premium multiple for the shares.

Beyond the coming tougher comparisons, there are a few things to keep on eye.  First, management indicated that operating expense growth in 2021 would be at the upper end of the guided range.  This is unusual as FB normally guides operating expenses and then comes in at much lower growth.  For now, investors are OK with elevated expenses as revenue growth can easily absorb the spending and investing in new growth opportunities is deemed wise.  Should growth decelerate more and sooner than expected this could still be an issue.  Regulatory changes from governments around the world as they investigate FB and other major platform companies are worth watching but are difficult to predict.  More news coming on this front in 2021.  Finally, unrelated to business fundamentals, FB shares remain in the center of the frequent rotation between growth and value stocks or COVID loser and COVID winner stocks.

FB is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.