Five key reasons why traders will like Facebook's earnings

Five reasons why Facebook is in a class of its own.

Source: Bloomberg
  • A wholly dominant business – Facebook (FB) along with Google make up a massive 85% of total US Q1 ad growth
  • The monetisation of Instagram – should add close to $2billion in revenue in 2016
  • A strong focus on core business – Messenger and WhatsApp have huge monthly users and are expected to launch ad products to help growth
  • Outstanding growth – in Q1, the consensus expects FB to record EBITDA growth of 44% and 48% sales growth (year-on-year)
  • Massive levels of operational expense (OPEX) – highlights innovation and a strong growth profile

What’s the trade?

Facebook reports its Q1 quarterly earnings on 27 April (released in post-market trade) and there is no doubt traders will give this a lot of attention.

Traders should be interested in the Q1 earnings release, not just because the fundamental story is incredible, but also because after a 31% rally between January and March, FB has had one of the best quarters in years. The risk of disappointment seems therefore high even if the earnings numbers are achievable.

As always, price action should be a trader’s guide, but with much goodwill in the price, buying weakness seems the right trade in my opinion. While hugely optimistic, $90 is the high conviction entry point (see weekly chart below), with a view to cut back on a daily close below $86. $100 may be a more realistic entry point for longs though, and as we can see from yesterday’s candle, traders have keenly supported price into $106.

Adopting a more momentum and trend based approach, buying FB on a close above the February/March double top of $116.17 would be positive too. The preference is to buy weakness into the $100 to $90 area, but a resumption of the uptrend and subsequently buying on a daily close above $116.17 is also a tactic I would employ.

Technical pictureSome signs of further weakness into earnings

Price has closed below the January uptrend and the eight-day EMA, and the upside momentum appears to have stalled – a fresh catalyst is needed. Importantly, the bulls seem to be supporting price into horizontal support around the $110 level (represented by the dotted black line). However, one cannot rule out a move into $100, and potentially even $90, which would be a strong buy zone.

A truly exceptional business

There are few names that the analyst community love more than FB. Granted, FB is a pure play on advertising (95% of its revenue come from advertising), but the pace of revenue growth, its absolute dominance in global digital advertising and its huge monthly average users (MAU) on all key platforms (Facebook, WhatsApp and Messenger) make it such a compelling investment story. Throw in a fairly simplistic business model, a strong focus on these core activities, excellent free cash flow (per share) generation, unbelievably high and sustainable gross margins, and multiple earnings catalysts through to 2017 means you have a stock that traders will be very happy to buy into where ever there’s any weakness.

The fact that operating expense is so high shows huge innovation and a willingness to push future profitability. However, I would look at total operating expense as a percentage of revenue. While this is likely to be around 50% in Q1, with its revenue profile, this percentage should fall in the coming quarters.

One just has to look at the weekly chart to see the beautiful uptrend and the pullbacks that have been clear buying opportunities. I expect this to continue.

Key earnings numbers to focus on

  • Q1 EBITDA 3.04b. How do the Q1 numbers feed into the full-year estimate of $15.48b?
  • Q1 revenue $5.251b (full-year estimate stands at $25.571b)
  • Gross margins 83.83%

It’s also worth highlighting that FB have beaten consensus EPS in eight consecutive quarters and revenue in seven out of eight, so its pedigree of beating expectations is excellent. Naturally, there is more for investors and traders to assess and we find FB has seen gains on the day of earnings in only four of the last eight quarters. However, the gains have been very strong when they do rally.

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