Facebook Stock Is a Bargain

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Meta Platforms (FB), the parent of Facebook, is a bargain now. Its latest earnings show that daily average users (DAUs) are up, not down, like last quarter. Its FCF margins rose as well. As a result, this makes FB stock look deeply undervalued.

Meta announced its Q1 results on April 27. It showed that DAUs actually increased from the prior quarter. They rose 1.6% from 1.92 billion DAUs to 1.96 billion DAUs. That doesn’t fit the narrative that short-sellers wanted to see after a slight quarterly consecutive dip in the prior quarter. But don’t let this worry you. FB stock is still cheap.

In addition, Meta Platforms generated huge free cash flow (FCF) during Q1. For example, FCF during Q1 was $8.52 billion, up 9.7% over last year at $7.81 billion. Moreover, this represents a 29.7% FCF margin on its revenue. This is a very high margin for most tech companies.

One reason for the weakness in FB stock has been the changes Apple (AAPL) made to its iOS operating system. This blocked data for advertisers based on its Identifier for Advertisers (IDFA) policy. Everyone with iOS was opted out by Apple from allowing advertisers to see details about any user. Only those who go to the trouble of allowing data for advertisers are allowed. According to Seeking Alpha, this could reduce its revenue by $10 billion this year.

However, that $10 billion is not even 10% of the $127 billion forecast by analysts on average this year, according to Refinitiv via Yahoo Finance. Moreover, given Meta Platform’s huge FCF margins, it looks like FB stock could be worth significantly more than its price today.

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Where This Leaves Investors

FB stock has taken a huge hit this year. YTD it’s down over 41%, even after rising 3.86% on May 13.

FB stock YTD as May 13, 2022

We can assume that at least one-third of its revenue going forward will turn into free cash flow. Based on $127.3 billion in revenue forecast this year and $148.6 billion next year, FCF could reach $42.4 billion in 2022 and $49.5 billion in 2023.

At 20 times FCF, That implies that FB stock could be worth $990 billion by next year (i.e., 20 x $49.5b). We use a 20x multiple since this is the same as dividing by a 5% FCF yield. A 5% FCF yield is a very conservative metric for a growing tech company. Many are valued at 3% and even 1% — much higher valuation metrics.

By comparison Meta’s existing market cap today is just $515.6 billion. So the target $990 billion market cap is 92% over today’s price. It implies that FB stock could be worth $375 per share.

Over two years that works out to an average annual return of 38.56% each of the next two years. One way to take advantage of this potential upside is to buy out-of-the-money calls that are not too expensive.

For example, the table below shows call options that are two months in the future for closing on July 15:

Meta Platforms — July 15 Calls

The $235 exercise price costs just $3.25 per contract which represents 100 shares. That means the cost is only about 1.6% of today’s price of $198.36. However, in order for this investment to be profitable, FB stock has to rise over $238.25 per share (i.e., the $235 exercise price +$3.25 option cost). This means FB has to rise a little over 20% in 2 months (i.e., $238.25/$198.36 = 1.201).

Since this breakeven level is so high, this is a speculative way to play FB stock. Nevertheless, there is a good chance this could hit. We have shown FB stock is worth 92% more, or 38.6% more on average each of the next 2 years.

For example, if after one month, FB stock has not moved up or the price of the call option is down, you can roll this play over by selling it and buying a new call option 2 months forward.

Just keep in mind that you can expect a lot of volatility buying out-of-the-money calls like this. Also, this is not financial advice, and you should only do this if you thoroughly studied call options, including their risks.

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