Stock

Four things that could derail Facebook's stock rally

November 18, 2013: 1:06 PM ET

Facebook's stock price has risen in the past year, but can that continue?

by Kevin Kelleher, contributor

131007101933-facebook-stock-614xa

FORTUNE – A year ago, few investors were bullish on Facebook (FB). Some writers argued that, at $23 a share, it was still overvalued. Others thought Yahoo (YHOO) under Marissa Mayer had a better shot at a turnaround. While some bears were beginning to temper their pessimism, the consensus view was that Facebook was expensive and speculative.

In the past year, Facebook's stock has risen 115%, against a 37% rise in the Nasdaq Composite Index. Of 40 securities analysts tracked by Thomson/First Call, 32 currently have a buy or strong buy rating, 8 have a hold rating and none have a sell rating. Even with the rally, short interest on the stock is a third of what it was a year ago.

What changed? The main reason for this reversal of fortune in Facebook's stock is the company's sudden growth in mobile ads. Back when the stock was languishing in the $20 range, Facebook vowed to monetize its audience's shift from desktop computers to mobile devices. That focus on mobile worked. A year ago, revenue was growing at only 32%. In its most recent quarter September, revenue grew 60%.

MORE: Microsoft, GE, and the futility in ranking employees

In the last few weeks, however, there have been a few signs that Facebook's impressive rally is running out of steam. Last week, the stock traded as low as $45.73, or 17% down from its record high of $54.82 one month ago. The stock was trading around $47 a share Monday. Is this decline an early sign of a downturn or just a quick sputter? Looking ahead, it's worth considering factors that could derail the Facebook rally.

Facebook's turnaround is priced into its stock. The company's recovery was so impressive it paradoxically set the bar of expectations higher even than it was when Facebook went public in May of last year. That has left Facebook very expensive, priced for growth that won't happen for a couple of years: Facebook is trading at 125 times its trailing 12-month earnings, and at 44 times its estimated earnings in 2014.

There are still several factors that will drive Facebook's growth: the company is better targeting its ads to deliver stronger returns for advertisers; it will start to sell more ads on Instagram and on Facebook videos; it can build a stronger third-party ad network; and advertiser demand for Facebook ads is showing no signs of slowing right now. That's a sunny forecast, but it's well known. It doesn't justify the stock moving higher from here.

Facebook will see growth rates decline again. Analysts are forecasting 50% growth in Facebook revenue for 2013 and 36% for 2014. That's with all of the growth initatives listed above. But all of this hinges on an important question with a very uncertain answer: How many more ads can Facebook load into its mobile feeds without driving away users?

In Facebook's last earnings call, CFO David Ebersman said the company "significantly" increased desktop ads but "modestly" increased those in mobile feeds. The company plans on keeping ads at around 5% of mobile-feed content, relying on growing usage and rising demand to maintain growth.

Since Facebook users are accessing the site on mobile devices, this could limit future growth. Facebook's mobile revenue growth in the past year has been strong partly because, a year ago, this revenue stream was so new and insiginificant. In coming years, the comparison's won't be so dramatic. In short, after a surprisingly strong year, Facebook's growth rates may plateau again.

Facebook may have problems buying new growth. When a big company's organic growth stalls, it's common to buy fast-growing companies. Mark Zuckerberg knows this, which is why his company bought Instagram when it was looking to become a leader in mobile picture sharing. In retrospect, that deal worked out much better for Facebook than for Instagram.

Last week, Snapchat spurned an even more generous offer from Facebook. The episode underscored how today's hot startups don't dream of being bought by Facebook, they long to supplant Facebook, which means remaining independent. Snapchat's founders were reportedly averse to working for Zuckerberg, while its VC backers weren't interested in the deal either.

There are thousands of startups that would love to be bought by Facebook at a rich price. But the Snapchats among them – the rare beast that resonates mysteriously with an ever-growing audience – aren't among them. To them, Mark Zuckerberg is The Man. And if you're really good, you don't sell out to The Man at any price.

Facebook continues to have a teenager problem. In the recent earnings call, Ebersman tried to put a positive spin on this. Although the company is "close to fully penetrated among teens," he said "we did see a decrease in daily users specifically among younger teens." The comments backfired, drawing new attention to the issue.

On the one hand, advertisers are more interested in older demographics that spend more money. On the other, this could be a long-term issue if teens grow older and don't migrate to Facebook's platform. Snapchat was supposed to help resolve this problem, but the failed deal only added to the image that Facebook is struggling to relate to a new generation of users.

MORE: Hummer Winblad partner preps own VC fund

One final development that is not necessarily a bearish sign but is worth considering. Last week, Ebersman sold $43 million worth of his shares, or 9% of his Facebook holdings, at around $47 a share. While the sale was part of a pre-arranged trading plan, it's also the largest stock sale by a CFO in the last decade.

Such pre-arranged trading plans were set up to allow sales without creating the appearance of insider dumping, which I doubt was Ebersman's intention. Still, there is something to be said about the timing. Arguably, no one has a better perspective on Facebook's financial outlook. It's not insider trading if your gut is telling you this is a good time to sell. It may, however, be an instinct other Facebook investors may want to note.

  • Pandora at the crossroads

    Growth continues as Pandora's stock is still rising. Is this the beginning of a new era?

    By Kevin Kelleher, contributor

    FORTUNE -- For all its promise and popularity, online music has proven to be pretty tough soil for companies to farm. Profits take years to produce and offer slim margins once they show up. Musicians complain about how you're treating them, even as the labels try to bleed you dry.

    And yet so MORE

    Oct 28, 2013 11:41 AM ET
  • Rough ride ahead for BlackBerry bulls

    The contrarians are being proved wrong.

    By Kevin Kelleher, contributor

    FORTUNE – It's getting hard again to be a believer in BlackBerry.

    Friday morning, the company looking for a turnaround in the hyper-competitive smartphone market posted its earnings for the three-month period ended June 1, 2013. To say that Wall Street had been divided over how well or how poorly the company had performed in the quarter is a bit of an understatement.

    Blackberry (BBRY) has MORE

    Jul 1, 2013 10:17 AM ET
  • The return of the BlackBerry believers

    It's over for the struggling phone maker, right? Not so, says a vocal contingent of analysts and investors. They think the company's worst days are behind it.

    Note: This story has been updated to reflect BBRY price changes on June 19.

    By Kevin Kelleher, contributor

    FORTUNE -- Has any company in the technology sector seen higher highs and lower lows in the past decade than BlackBerry?

    If you remember, BlackBerry (BBRY) -- which earlier this MORE

    Jun 19, 2013 5:00 AM ET
  • Netflix bulls vs bears: Who has the upper hand?

    Few stocks are as divisive as Netflix.

    By Kevin Kelleher, contributor

    FORTUNE -- Netflix and the Nasdaq 100 Index are something like one of those break-up to make-up couples. In December 2010, Nasdaq entered the index -- a benchmark more focused on leading companies than the broader Nasdaq Composite -- after the stock more than doubled in the previous year to $200 a share.

    Two years later, after a controversial move to MORE

    Jun 5, 2013 7:21 AM ET
  • IPO: May be hazardous to CEO health

    Initial public offering side effects include first-day pop followed my painful malaise. Take with caution.

    By Kevin Kelleher

    FORTUNE – First Groupon fired Andrew Mason. Now Pandora says Joe Kennedy is leaving Pandora. Being a CEO of a company that made a splash in the public markets with high-flying IPOs is starting to look like a job hazard.

    Pandora (P) priced its shares at $16 in June 2010. On its first day of trading, MORE

    Mar 8, 2013 10:02 AM ET
  • Is it finally prime time for TiVo?

    After ten years of toiling in the DVR sector with a we-try-harder attitude, here's what has changed for TiVo.

    By Kevin Kelleher, contributor

    FORTUNE --  A decade after it changed the way we watch TV, TIVO may be embarking on a second act.

    Founded in 1997, the Alviso, Calif., company pioneered software to manage digital video recording, or DVR. Its interface made finding and recording TV programs an intuitive experience. TiVo (TIVO) hit on MORE

    - Jan 28, 2013 9:17 AM ET
  • Apple's extra week and other anomalies in last week's report

    Stuff that went right over most analysts' -- and nearly every reporter's -- head

    FORTUNE -- As predicted, the headlines reporting Apple's (AAPL) quarterly earnings last week -- and the market's immediate and violent negative reaction -- failed to take into account that Q1 2013 had one less week Q1 2012. Even Tim Cook did lousy job explaining it.

    It fell to the Braeburn Group's Robert Paul Leitao, an independent investor who MORE

    - Jan 28, 2013 3:33 AM ET
  • Facebook: The worst may be over

    Yes, the stock price is still down, but it has staged an impressive rally. Here's why it could continue to climb.

    By Kevin Kelleher, contributor

    FORTUNE -- Is the worst of the Facebook sell-off over?

    Two weeks ago, Facebook (FB) shares -- offered in May at $38 a share -- slipped as low as $25.52, a mere two bits away from fulfilling the price targets of $25 a share that some of MORE

    Jun 21, 2012 11:27 AM ET
  • Facebook's fate: Bulls versus bears

    Is Facebook entering a painful period of decline? Or, will it surge beyond its struggles? Here is the case for both.

    By Kevin Kelleher, contributor

    FORTUNE – It's been more than two weeks since Facebook went public, and it's getting harder to blame the 30% drop in its market value on the trading glitch that marred its debut. Nothing, not even the many privacy controversies that have plagued Facebook's short history, MORE

    Jun 5, 2012 7:50 AM ET
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.