Big Can Get Bigger: updated thoughts on Facebook

Checking in on my largest personal holding

By Travis Johnson, Stock Gumshoe, July 28, 2016

Do investors have a tendency to overreact to trends and fad worries?

Yep.

Despite all the concerns about Facebook (FB) losing “eyeball time” to Pokemon Go or losing the “cool kids” to Snapchat or just saturating the market and getting overvalued, Facebook AGAIN blew out earnings expectations this quarter (reported on Wednesday evening) by doing dramatically better on the top line and bottom line than analysts had expected.

And it wasn’t close, and it wasn’t some sneaky financial engineering to make the numbers look better: If you look through the analyst expectations about average user metrics and revenue metrics, Facebook beat on almost every single one of those metrics, almost everywhere in the world. And not by a whisper, but by a shout.

As I’ve noted before, being staggeringly huge doesn’t mean you can’t get bigger — particularly if you’re part of a duopoly (with Google) that’s got mobile digital advertising and internet advertising in a vice grip. Being the fastest-growing provider in a large market (mobile advertising) that itself is growing quickly means the ceiling is probably a lot higher than you want to believe. Growing market combined with growing market share creates “double growth” — and they grew even faster by also increasing the average revenue per user by increasing the “ad load” (the number of ads each user sees).

Yes, it’s hard to conceive of a $350 billion company that can grow rapidly, and the growth will almost certainly slow as they become larger, but the practical limit on Facebook’s revenue and earnings is not some expectation that a company can only grow to some pre-imagined size. The practical limit is the size of the market in which it operates, whether that market is growing, and whether the company can continue to take market share without sacrificing margins.

Digital advertising is a fast growing market around the world, with annual revenue of roughly $200 billion (depends who you ask, of course — it’s just shy of $70 billion in the US, with more than 60% of that now coming from mobile traffic), and Facebook has something like 10-15% of that market.

If they grew to take on as large a market share as Google, that would mean Facebook more than doubles their market share and reaches annual revenue of something in the neighborhood of $60 billion. That’s very hypothetical, of course, but also ...

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