This week, I give my take on whether Facebook's (US:FB.) long-term prospects justify its large weighting in many investors' portfolios. In the rest of my round-up, which Alpha subscribers can read here, I took a look at the recent acquisition strategies of Restaurant Group (RTN), WH Smith (SMWH) and Reckitt Benckiser (RB.). Plus, I reflect on Next's (NXT) third quarter trading statement.
According to Morningstar, Facebook is the fourth biggest holding (5.2 per cent) of Terry Smith’s Fundsmith Equity fund. I am a big fan of Terry Smith and his style of investing, but I must admit that I was a little surprised to see him take such a big portfolio position in Facebook.
Yes, Facebook ticks a lot of boxes in terms of it being the dominant company in its space with a business of such scale that is very difficult – if not impossible – to copy. It also has very high profit margins, a high ROCE and generates lots of free cash flow.
But how does a business that is already very big, get much bigger? The other potential problem for this company is that it makes virtually all of its money from advertising and people are going off the idea of a company mining their personal data to make money from them.
At the moment, concerns about privacy are not hurting Facebook’s revenues which increased by 33 per cent during its third quarter. The one concern is that growth in average revenue per user (ARPU) is moderating and might be difficult to increase in the future.
Facebook’s efforts to reassure its users about privacy is hurting its profitability. A big rise in headcount saw operating costs rise by 53 per cent, which saw operating profits increase by just 13 per cent. Operating margins fell from 50 per cent a year ago to 42 per cent. Costs are set to increase further which is likely to put further downward pressure on margins.
Analysts’ forecasts for revenue growth still look to be very bullish, but margins are expected to come down to 38 per cent by 2020. The problem I see for Facebook is that its core social network is very mature. Younger people are increasingly drawn to its Instagram and WhatsApp products that have no adverts, with the latter liked for its encryption and privacy. It’s difficult to see how putting adverts on to these two services is going to work.
If analysts’ forecasts are right though, on just under 19 times rolling one-year forecast EPS, at a price of $152 the shares do not look too expensive. The very real risk, however, is that revenues fall short and costs overshoot. That would make the shares too risky for me.
Alpha subscribers can read the rest of my round-up, made up of news and announcements from companies which caught my eye, here.
