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Facebook Inc (NASDAQ:FB) stock has faced resistance due to fears of revenues growth slowdown.
Despite the recent rally, Facebook stock has underperformed the Nasdaq Composite in the last three months even though the company had delivered strong earnings results. FB stock has come under pressure on several occasions. For a while now, social media giant Facebook Inc (NASDAQ:FB) has been warning its investors about the possible slowdown in Facebook revenue growth due to ad load saturation in the news feed.
This has raised concerns among investors and has acted as a resistance to FB stock on occasions, though strong growth of Instagram has alleviated some of the concerns. Facebook CFO Dave Wehner has been cautioning FB stock investors and analysts during the earnings calls since early 2016. During the FY 2016 second-quarter earnings call, he had said that ad load growth will slow down in coming months and will become a less significant factor driving revenue growth after mid-2017.
Ad impressions growth slowed in the third quarter.
He went on to reiterate the warning in the following earnings calls. In the second quarter of 2017, Mr. Wehner had warned that "we continue to expect that Facebook ad load will play a less significant factor driving advertising revenue growth going forward". And this scenario did play out in the third quarter this year. The number of ads delivered increased by only 10% in the previous quarter compared to 50% growth reported by the company in the comparable quarter last year. For the nine months of this fiscal, the number of ads delivered increased by 20% compared to 50% growth in the corresponding period in the last fiscal.
Given that ad delivery growth has been historically a strong growth driver for Facebook revenues, this slowdown could have a real impact on FB revenues. However, if you look at the companies performance in the previous quarter, the social media giant reported better than expected performance on most of its metrics. Facebook revenues jumped by a massive 47% from $7.01 billion a year ago to $10.33 billion in the previous quarter. Advertisement revenue saw even impressive growth of 48.8%. Given this strong revenue growth, should investors worry about the ad load saturation? What are the factors driving the ad revenue growth and are they sustainable? Should you by Facebook stock?
In its 10Q filing with SEC, the company identified three factors which are driving the ad revenue growth: (i) an increase in average price per ad, (ii) an increase in users and their engagement, and (iii) an increase in the number and frequency of ads displayed on mobile devices. The third factor will continue to become less significant in the coming quarters. However, this is likely to be offset by the increase in ad prices.
Facebook Inc ads in huge demand.
During the third quarter, the average price per ad increased by 35% compared to 6% increase in same quarter last year. For the nine months of this year, the average price per ad is up by 25%, a massive improvement over 7% growth in the corresponding quarter last year. So, what is driving the ad prices higher? Firstly, there is an increase in overall spend on digital ads from existing marketers. According to an eMarketer report, digital ad spending in the U.S is expected to grow from $72 billion in 2016 to $113 billion by 2020. In the same period, TV ad spend will see a marginal rise from $71 billion to $77 billion.
Add to it, the number of advertisers on the Facebook platform is rising, leading to more demand of ad space. In April, Facebook announced that more than 5 million businesses advertise on its social network every month, an increase of 1 million (25% growth) since September last year and 2 million (67% growth) more advertisers than it had in March 2016. However, the number of ads served is not growing fast enough, leading to classic demand-pull inflation where too much money is chasing the limited supply of ads inventory.
Will the ad price growth sustain?
Ad price rise is likely to persist in the coming quarters, padding the companies advertising revenues. Its unparalleled scale and the ability of hyper-targeting have been huge draws for marketers of all sizes. With over 2 billion monthly active users, the company provides huge catchment area to advertisers. The return on investment for advertisers on Facebook platform remains high compared to other platforms. According to an eMarketer report, 95% of social media marketers who responded to a survey said that Facebook produces one of the best ROIs for advertisers. Twitter came in second with 63.5% respondents saying its returns one of the . Given this high ROI and huge catchment area, marketers continue to flock to Facebook's platform.
Secondly, Facebook's ad pricing is currently lower compared to other social networking sites. According to Morgan Stanley, Facebook Newsfeed ad rates per thousand impressions is as low as $2, lower than Snapchat and Instagram, while Facebook Video ad prices per thousand impressions range between $6-$12, compared to $15-$20 for Pinterest video and $35+ for YouTube Google Preferred videos. This gives Facebook enough room to raise its ad prices.
Facebook stock will face resistance in the short run.
While Facebook's ad business will continue to churn revenues in the coming quarter, Facebook stock is likely to face resistance in the short run due to factors discussed earlier. The company has announced a possible 45% increase in operating expenses next year which is likely to impact the company's profit margins and earnings. The company has also hiked up its investment plans for the next year. Additionally, Facebook has taken a lot of heat from regulators and public alike for the Russia controversy. All these factors are likely to weigh on Facebook stock for the next few weeks. However, Facebook stock's long-term potential is encouraging. FB stock is a good long term buy. Facebook stock is part of our best stocks to buy portfolio which has outperformed the Nasdaq Composite by over 145%.
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