I have a confession: The day I started on Wall Street, my boss handed me a yellowing copy of Benjamin Graham and David Dodd’s 1934 book, “Security Analysis.” He told me Warren Buffett swears by it! I read maybe three pages before the section on valuing railroad bonds put me to sleep. I still have the book, which is now a doorstop. What I quickly realized was that only three things matter when investing in technology: growth, growth and growth.
Last week Facebook announced that its quarterly earnings grew 61% year over year, amazing for a company with $40 billion in revenue. The stock is up a similar amount since the start of 2017, but some cracks are showing in user engagement and growth. Is Facebook really worth $553 billion? Has it peaked?
The company certainly is under fire. Too many people falsely believe that fake news on Facebook got Donald Trump elected. Like cockroaches, critics calling for regulation are scurrying out of the woodwork. Salesforce CEO Marc Benioff thinks Facebook is so addictive that it should be controlled like cigarettes. George Soros told the Davos crowd that Facebook and Google are a “menace, and it falls to the regulatory authorities to protect society against them.”
Some critics even think Facebook is too successful and should be broken up, though the Federal Trade Commission would have to search far and wide to find consumer harm. Now there is a call, led by News Corp ’s Rupert Murdoch, for Facebook to pay publishers like this newspaper for their content. (News Corp is the parent company of Dow Jones, which publishes The Wall Street Journal.)
Under pressure last month, founder Mark Zuckerberg announced changes to Facebook’s “news feed” that would emphasize posts from family and friends rather than outside publishers. Considered as a business proposition, this is a loser. Will more of grandma’s fruitcake recipes keep Facebook users clicking? It almost answers itself. “In total, we made changes that reduced time spent on Facebook by roughly 50 million hours every day,” Mr. Zuckerberg said last week. Yet investors yawned, and the stock rose 4%.
The company’s biggest threat is simple: Facebook is running out of people. In March 2007, when I sat down with Mr. Zuckerberg for a Journal interview, he bragged about having 16 million users. In its early years, Facebook was limited to college students, and critics suggested he would soon run out of them. They were right! Which is why the requirement to have an email address ending in .edu was soon dropped. Today 2.14 billion people use Facebook at least once a month.
Chew on these numbers: There are about 3.5 billion internet users today—less than half of the world’s population. It might seem like that leaves plenty of room for growth, except that about 750 million internet users are in China, where Facebook is blocked. Another 110 million or so are in Russia, where most use the homegrown social network VKontakte. That leaves Facebook with only a few hundred million potential recruits, mostly in India, Japan and Africa. Its reach is amazing, but this doesn’t leave much room to grow. In the lucrative U.S. and Europe, user growth is basically flat.
Facebook’s monetization business—selling ads next to your cat pictures—has been booming. In 2012 mobile was less than a quarter of its revenue. Now it’s most of its sales. Just when the ad industry got hungry for smartphone inventory, Facebook arrived with a solid platform to deliver. But too much of the past year’s revenue growth came from raising prices. That’s dangerous.
Does Mr. Zuckerberg have other levers to pull? Facebook owns Instagram and WhatsApp, each with a billion or so monthly users. But neither is great for mobile ads. Plus, much of their ad growth would come at Facebook’s expense.
The growth wild card is video. Did you even know that Facebook has a “Watch” tab? It isn’t for user-generated content—what Hollywood calls loser-generated content—but for professionally created clips and shows. Facebook said last year it would spend $1 billion on original video in 2018. The idea is intriguing: Let cord-cutters enjoy streaming content sponsored by advertisers. But Facebook is way behind. Netflix will spend almost $8 billionon shows this year, Amazon another $5 billion or so. HBO and Disney are figuring out internet delivery. They don’t need Facebook to do it.
When user growth peaks, earnings growth is going to be hard to come by. Facebook’s stock, today priced at a rich 14 times revenues, may emulate one of those bungee-jumping videos I just watched. Maybe Facebook could buy Netflix ($116 billion) or even Disney ($164 billion) while its stock is roaring. But don’t count on it.
The day Facebook actually peaks will only become clear in a rearview mirror. But investors should note all the signs along the way.