Investors have been nervous about purchasing Facebook shares following the company's second-quarter earnings release, despite Facebook's 20% net income beat vs. Wall street's expectations for the period. Facebook's forward price-to-earnings ratio has been compressed 4% since then, while its stock has lagged the broader group, which includes Etsy (ETSY) , Groupon (GRPN) and Yelp (YELP) , by 3%.
The reason for the market's trepidation has been comments made during the company's earnings call suggesting that Facebook anticipated that ad load will continue to be a strong growth driver this year, but will eventually begin tapering off in the second half of next year. Ad load refers to the places on your timeline that Facebook can place ads without changing your experience on the site.
Ad load has been growing in recent years, but the company now believes that it is running out of real estate.
"Facebook has become a target recently for analysts who are worried about whether or not the company can sustain its prolific growth rates. Given that FB keeps hitting all-time highs, it is understandably an easy target for those calling out a 'high valuation,'" AAP senior analyst Scott Berman said in an email exchange today. "But in looking at its growth rates, which will continue to be strong for years to come, the stock is actually not that expensive compared to many of the companies in the S&P 500, especially if you are looking for growth."
Morgan Stanley analyst Brian Nowak believes that the company has at least three other growth drivers in its pipeline that will offset any ad load concerns the company has in 2017. As a result, the firm raised its price target on the company to $160, potential 23% upside over the stock's Tuesday closing price of $129.73.
"We see the monetization roll-out of Instagram adding $1.8 billion of incremental revenue in 2016. We are also positive on FB's ability to continue to innovate and improve its monetization (carousel ads, dynamic ads, video ads). Combined with high and growing engagement, we see monetization upside going forward," Nowak wrote.
In Morgan Stanley's view, Facebook's growth prospects are keyed by four factors: average pricing, user growth, time spent per user, and ad load. And while ad load growth is expected to slow, strong user growth and engagement will be enough to offset that segment's waning prospects.
The firm points out that Facebook had 1.1 billion daily active users in the second quarter of 2016, a 17% increase over the same period last year, while the average daily active user spends about 51 minutes per day across Facebook, Instagram and Messenger. The firm estimates that Facebook will reach 1.2 billion daily users by the end of this year with 14% and 10% year-over-year growth in 2017 and 2018, respectively.
"Ad load is only one factor driving FB, as its scale and strong engagement are more important, together driving an estimated 57% of FB's '16 ad revenue growth. FB's growing base of engaged users gives it more ad impression opportunities and data to serve higher quality ads," Nowak wrote. "Recent strong DAU and engagement trends cause us to sharpen our forecast."
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