Facebook (ticker symbol: FB) needs no introduction as the social media network that even has a movie written about it. But it may be less clear whether the stock is a buy or a sell?
Has Facebook grown so large with 1.3 billion plus daily active users that the upside is limited? Or is Facebook just getting started monetizing its massive user base by disrupting email with Facebook messenger, and creating virtual worlds following its purchase of Oculus?
Depending on whether you are an investor or a trader, you will need to examine the company through different lenses.
If you are an investor, fundamental analysis will be important to examine whether the stock is undervalued or overvalued. As a trader, you could look to analyze technical chart patterns.
So is Facebook a buy or a sell?
Facebook Chart Patterns
Technical traders use chart patterns to make buy and sell decisions. When certain FB share price levels are breached, order entries and exits are triggered.
It is tempting to make buy and sell decisions by observing recent share prices. But rather than transacting based on the latest share price movements, which are often random in nature, consider using chart patterns as your guide to making more systematic trading decisions.
Technical analysts or chartists examining FB stock price today may use some of the following chart patterns to make buy or sell decisions.
COMMON FB STOCK CHART PATTERNS
Chart patterns commonly followed by technical traders include:
| Chart Pattern | Bullish Or Bearish |
| Cup With Handle (continuation) | Bullish |
| Ascending Triangle | Bullish |
| Triple Bottom Reversal | Bullish |
| Falling Wedge Reversal | Bullish |
| Head and Shoulders Bottom Reversal | Bullish |
| Double Bottom Reversal | Bullish |
| Head and Shoulders Top Reversal | Bearish |
| Triple Top Reversal | Bearish |
| Rising Wedge Reversal | Bearish |
| Descending Triangle | Bearish |
| Double Top Reversal | Bearish |
If you choose to buy or sell Facebook stock based on chart patterns, you will generally want to follow standard technical trading practices, such as setting stop losses to avoid losing more than a fixed amount if FB share price were to move against your expectations.
As a short term trader, pay close attention to the commissions costs of buying and selling regularly as well as the impact of short-term capital gains tax.
While these costs may be a headwind as a technical trader, a tailwind may come in the form of algorithmic trading. But what is algorithmic trading?
ALGORITHMIC TRADING
Algorithmic trading is based on programmed rulesets that execute orders when certain conditions are met.
Some estimates claim that as much as 60% of market trading stems from a combination of passive investing and algorithmic trading.
As a technical trader, you can virtually piggyback on the big money algorithmic traders by betting in the same direction.
But making buy or sell decisions based on Facebook stock chart patterns is not without its risks.
TECHNICAL TRADING RISKS
A primary risk when trading chart patterns comes from the movement of stocks after major news events. Facebook stock news streams all day long but which news events can disrupt its technical trading patterns?
One predictable event occurs quarterly when Facebook announces earnings, the stock price can pop or drop by large percentage amounts. The fundamental news event pays no heed to shorter term technical chart patterns – the stock can gap higher or lower depending on how earnings are received.
If there were only one golden rule to abide by when trading Facebook based on chart patterns, it would be to pay heed to predictable events that could derail its technical trend.
Earnings is one example but legal risks, changes in senior management personnel, acquisitions, and new business initiatives could also substantially impact Facebook share price. Another event which often moves the share price is its developers conference.
If you are concerned about the share price declining following one of these events, a married put is one of the best options trading strategies and a powerful hedging strategy to limit risk.
>> Related: How To Trade Options
FB Stock Price & Valuation
As a fundamental analyst, you can compare FB stock price to its intrinsic value to see whether the FB share price is above or below its fair value.
Another popular approach to making a buy or sell decision is to calculate the fair value of Facebook.
This investing method is common among institutional investors who rely on research from Wall Street analysts to guide investing decisions. This research generally examines key factors that will drive revenue and profitability.
For example, how many daily active users are engaging with Facebook and for how long? How many ads are served and what is the average pricing by region? Do competitors, such as Snapchat and Twitter, pose a major risk to Facebook? Is the market size growing or shrinking?
After a rigorous research, financial analysis is conducted to assess the company’s theoretical fair value. If the share price is low compared to the fair value, it might be time to buy FB stock.
Commensurately, a share price well above fair value might suggest it is time to be cautious because the stock may be overvalued.
The following valuation models were used in the graphic below to assess whether Facebook stock value is compelling:
- 5 Year DCF Growth Exit
- 5 Year DCF Revenue Exit
- 10 Year DCF Growth Exit
- 10 Year DCF Revenue Exit
- P/E Multiples
- EBITDA Multiples
- Revenue Multiples
You can see below not only the fair value estimate but also the market price and Wall Street analysts’ expectations.
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Facebook Stock Price History
The Facebook stock price history reveals its history of volatility, which you should consider relative to your own risk tolerance for price swings before buying.
The long term Facebook stock price history chart is a helpful indicator to both traders and investors to assess how volatile the share price has been over time.
A good rule of thumb to gauge whether a company would be a good fit in your portfolio is to calculate the share price range from one year to the next, and ideally from peak to trough.
A Facebook stock analysis gives you insight into whether the volatility meets or exceeds your expectations and risk tolerance.
If a 25% swing in a single year would be too much to bear, then perhaps another company would be a better fit for your portfolio.
If you are keen to buy the stock but want to limit risk from potential volatility, consider hedging strategies using options.
To get a better sense of timing entries and exits, shorter term stock charts are helpful.
Casual investors often buy when stocks are moving higher and sell when share prices decline. But paradoxically even though it takes more courage to buy when stocks move lower, that is precisely when they may be “on sale” and offer better value.
As the old stock market investing quote from Warren Buffett goes:
“Be greedy when others are fearful and fearful when others are greedy”
>> Related: How To Generate Income From Stocks You Own Using Covered Calls
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Facebook Revenues & Earnings
The growth of Facebook revenues is a key indicator that informs investors about the likely profitability of the company in the future. When revenue growth slows, profitability is likely to stabilize or slow too, and investors tend to apply lower multiples to these companies, which can hurt share price performance.
The implicit goal of just about every public company is to “maximize shareholder value” by growing revenues and profits.
Some companies, like Apple, have managed to grow revenues while keep high profit margins.
But more often than not, profit margins decline when companies get very large. For example, Walmart and Amazon are huge but have historically had much lower profit margins than Apple.
Facebook enjoys a business model similar to Google whereby the marginal cost is low for every additional click on an ad.
The more ad clicks, the higher the revenues – and because incremental costs are low – the higher the profits.
The Total Historical Revenues for Facebook are displayed in the graphic snapshot below:
When profits are growing rapidly, the price-to-earnings multiple is generally elevated to reflect the fast growth.
As earnings growth slows, price/earnings multiples contract. These lower earnings multiples are generally accompanied by a transition where growth investors sell and value investors buy shares in the company.
Facebook P/E Ratio
The p/e ratio for Facebook measures its current share price relative to its earnings per share.
Price/earnings ratios are a popular barometer to measure company valuations. A large company growing at a modest pace may trade at a lower price/earnings multiple than a fast-growing company winning market share in an expanding market.
On their own, P/E ratios are helpful but when you flip them upside down you get a much more intuitive ratio. For example, a price-to-earnings ratio of 50 means that the earnings yield is 2% (because 1/50 = 2%).
Another way to think about this ratio is that if you held the stock for 50 years, the company would produce profits equivalent to the principal you invest today (ignoring inflation and the time value of money).
You might think it’s definitely better to choose a low price-earnings multiple as a result, and it is true that lower multiples translate to higher profitability yields. But lower multiples are generally associated with slower growth too.
You may enjoy higher dividends by investing in a company with a lower price/earnings ratio but share price advances will generally be more muted.
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Facebook Return On Invested Capital (ROIC)
Facebook’s return on invested capital gauges the profitability and value-creating potential of the company after factoring in the amount of capital invested.
Among the most prized and watched financial metrics among sophisticated investors is return on invested capital (ROIC).
ROIC measures how efficiently a company allocates capital to profitable investments.
There are lots of ways to calculate return on invested capital, including:
- Add book value of equity to book value of debt and then subtract non-operating assets
- Subtract current liabilities from current assets to get working capital and then remove cash and add to the company’s fixed assets.
ROIC is an annualized percentage figure based on the trailing twelve months. If it is greater than the company’s weighted cost of capital (WACC), the company is deemed to be creating value.
Historically, Facebook’s ROIC has been highly competitive compared to its rivals:
Facebook Debt To Total Capital
A company earning more from borrowed capital than it pays in interest may decide to issue corporate debt. Facebook has little need for debt because it can grow rapidly without relying on tangible assets the same way other companies do; for example a grocery store, an alcohol brewing company or a manufacturing company.
Many fast-growing companies are initially financed by venture capital and have no need for debt capital. After they go public, they have little need for debt because they receive shareholder capital.
But over time even big technology companies, such as Apple, have issued debt when it makes financial sense. For example, when a company can earn more on its borrowings than it pays in interest to lenders.
Companies with tangible assets are more likely to take on debt to grow. For example, Coca Cola may choose to take on debt to build a production facility or expand its distribution network, whereas Facebook has little need to take on debt.
Facebook WACC
The weighted average cost of capital, or WACC, for a company is the rate it pays to its security holders to finance the firm’s assets.
Both shareholders and bondholders expect to earn a yield from interest payments, and the WACC measures their requirements.
For example, assume a company needs $1,000 to operate and borrows $500 from lenders and accepts $500 from shareholders.
If the shareholders demand a 20% return on their money while the lenders stipulate a 10% return, then the WACC would be 15%, so the company would need to produce a 15% return to satisfy equity and debt holders.
For Facebook, the weighted average cost of capital is shown below:
Facebook Financials
Facebook financials and a 5 year DCF Revenue Exit model are shown below:
The author has no position in any stocks mentioned. Investormint does not own or recommend any stocks.
Have you bought Facebook stock? What factors did you use to make your buy and sell decisions? How did it work out for you and what lessons did you learn? Enter your comments below.
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