For decades, hedge funds and value investors like Warren Buffet have been proving the efficient market thesis (EMT) wrong; with higher-than-market returns in almost every year of active investing, these investors have proven that they can beat the market because it is not perfectly efficient. In several cases, the market’s irrationality demonstrates itself clearly. In the case of after-hours trading of Facebook (FB) after its earnings yesterday, that irrationality played out clearly–and faced a heavy correction in the next day’s trading.
Positive Revenue and Earnings
To begin, Zolio recommends reviewing Facebook’s earnings presentation and the 25 slides outlining the company’s performance. We also recommend listening to the full earnings call and reviewing the earnings call transcript, which Seeking Alpha kindly provides for most major public companies. Also useful is the press release published on Facebook’s corporate webpage.
The key data points: revenue increased by 40% on a year-over-year basis to $1.585 billion. Advertising represents 84% of total revenue, and increased by 41% on a yearly comparison basis. Earnings on that revenue rose on a year-over-year basis by 13.3% to 17 cents per share.
Expectations were $1.53 billion revenue and EPS of 15 cents, so Facebook beat on both counts.
So why did Facebook stock fall by over 10% in after-hours trading, and only recover in late afternoon today?
Whisper Numbers
Wall Street has two lines of expectations: the published analyst view and the unpublished view.
Facebook beat the published numbers, but not the rumored numbers, causing institutional investors to panic and sell off rapidly in after-hours, followed by the so-called “dumb money” whose reactions may have been a mix of fear and blind obedience to the bigger institutional traders.
Fundamental Performance
This is a great case of market inefficiency, and one that the market quickly corrected on Thursday as the fundamental performance of Facebook’s business model was scrutinized by more careful, and more serious, investors. Facebook’s earnings were full of positive data points, especially if you look more closely at the slides and listen carefully to the earnings call.
1. Mobile is monetizing quickly and robustly. In slides 5 and 6, Facebook shows how mobile only usage of the site has grown tremendously. While mobile advertising is a tricky issue for many publishers and platforms, Facebook has been able to make this transition while maintaining growth in its average revenue per user (ARPU–see slide 12). On the earnings call, management acknowledged that 23% of ad revenue was coming from mobile; it was 0% a year ago. Management also pointed out that the performance of those mobile ads is strong enough to encourage more advertisers to embrace it as an advertising option.
2. Facebook Exchange is a growing product. Meanwhile, desktop-only ad performance has improved thanks to a product released by the company called Facebook Exchange. COO Sheryl Sandberg said this of FBX:
“Despite only becoming available to all marketers in September, by December FBX served nearly 1 billion impressions daily and supported over 1,300 advertisers each day. Large and small advertisers alike are seeing higher click-through rates, lower cost per conversion, and strong incremental reaches in FBX.”
The fact that impressions are growing and FBX is providing a value-added advertising option to advertisers, suggests that the company can expand this side of its operations in addition to mobile.
3. International growth is strong. Facebook is getting smarter at targeting international markets, and it is paying off very quickly. Slide 8 shows how Europe revenue grew on a year-over-year basis by 21.9%, despite the fact that much of Europe is in a recession right now. Asia has also been hit recently by macroeconomic pressures from a cooling China (a China cooldown is directly impacting regional countries who heavily depend on trade with the country), yet revenue from that region grew by 72% on a year-over-year basis. These numbers are much stronger than the previous quarter’s, and contribute to growth in North America, where revenue grew by 37.5%.
4. Facebook is growing up fast. In addition to the strong numbers, Facebook management did an excellent job fielding calls, explaining its earnings, and giving a clear vision of its future. Management seemed experienced, in control, and professional–a sharp contrast from earlier earnings calls, where poor executive performance lead to lingering doubts about the company’s maturity. Those doubts should be behind any shareholder in Facebook now.
Future Uncertainty
Yet the future is always uncertain, and savvy investors are always wary. Facebook’s strong performance in the fourth quarter of 2012 was on just about every front imaginable despite tough economic conditions worldwide, but the secret expectations for Facebook were much higher. Hence the drop. Any value-based investor could see in this a great buying opportunity: the fear of Facebook undervalued its stock, and allowed for a cheap buying opportunity.
Those value investors, including some swing traders, pounced early morning on Facebook. Those who bought in pre-market trading could buy for $29, and sell at $31 by lunch. 6.8% profit in four hours just by knowing the market was inefficient, and making a big mistake.
There is still concern going forward; Facebook is in a very competitive market, which puts risk on the business model. It’s also a high-profile stock in a high-growth market, making it extremely volatile. Plus its fundamentals would offend most value investors: a P/E near 300, 19% institutional ownership, a recently reported loss and an uncertain and very new market. There is no way to know if buying and holding Facebook for the next 3-5 years is a great investment decision. But investor response to Facebook’s earnings on Wednesday showed that there are ways to play the contrarian and make a quick buck, or at least see how the market can make some very stupid mistakes.