On paper, Facebook Inc. (NASDAQ: FB) is a great stock.
The tricky part is figuring out if we can trust what's on paper.
After a slight miss on revenue in its second quarter, the social media giant fell 19% in one day in late July. It was a record-setting $119 billion drop in market value. CEO Mark Zuckerberg alone lost $17 billion in net worth in a day.
The stock rebounded shortly after, but it didn't last. Shares are now down more than 20% from their late July peak.
According to the numbers, the correction is an overreaction.
After all, Facebook beat expectations for earnings per share. And even though user growth has slowed, revenue per user went up.
The stock's trailing and forward price/earnings (P/E) ratios both suggest a 25% rise.
In fact, the numbers are so strong that our Money Morning Stock VQScore™ system gave it a top score, indicating that it's undervalued and ready to rise.
But it's not the numbers that have pushed Facebook's stock price so low. The stock has been hammered because of issues like "fake news," the Cambridge Analytica scandal, Russian agents, Congressional hearings, and people's growing sense of mistrust.
The thousands and thousands of words in the media that have been skewering Zuckerberg and his team over the last several months certainly haven't helped either.
As a headline from Wired put it earlier this year, Facebook has been going through a "hellish" two years since reports of Russian election meddling first surfaced. And the recent plunge in stock price shows that many people aren't sure if the company will ever get out of it.
So just looking at the numbers isn't enough. If we're going to call Facebook a "Buy," we have to dig deeper and see if the company is doing what it needs to do to overcome its troubles and get back to delivering big profits for its shareholders.
The short answer is that the numbers are right. Facebook is a stock to buy.
In fact, now may be the best time ever to invest in Facebook, before it rises from these ashes.
To explain why, let's look at how it fell so low in the first place.
Where Facebook Went Wrong (Before Making It Right)
There's no sugar-coating it: Facebook management should have known better.
While it was a noble goal to connect people across the world, Facebook should have known its platform could be used for ill as well.
And to some extent, it did. That's why a Facebook client couldn't get away with advertising cigarettes to kids, for example. And at least an earnest - if not perfect - effort was made to crack down on online bullies.
But something as big as a coordinated misinformation campaign to influence an election just wasn't on Facebook's radar.
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It was an unfortunate side effect of the successful flattening of the hierarchy of information: making all information shareable, accessible, and in the same place.
That sounds like a democratic ideal. But when there's no difference between an article from The New York Times and a meme shared by your conspiracy-minded cousin, there are serious consequences for our ability to separate fact from fiction.
What's more jarring for some people is the way advertisers are able to target them on Facebook.
One of Facebook's selling points is not just that it can provide so many users to advertise to - with over 2 billion monthly active users worldwide - but that it can pinpoint them according to their demographic, location, taste, behavior, ideology, and more.
Every click and every word typed on Facebook becomes data that can be used by the company for ad-targeting purposes.
There's even a persistent rumor that Facebook is listening to users' conversations when they're not logged in.
Many people claim that they're seeing ads pop up on Facebook for products they were just talking about out loud. The theory is that the company has hijacked their smartphone microphones in order to advertise to them more effectively.
It's almost certainly not true. The resources required for such an endeavor would be astronomical even by Facebook's standards.
But whatever the mechanisms are, Facebook's ability to deliver such precisely tailored ads to its users clearly gives a lot of people pause.
Perhaps worst of all was the way Cambridge Analytica was able to collect data points on tens of millions of users via a scam "academic survey." Users who took the survey might have given their consent (whether or not they understood that they were doing so). But Cambridge got access to those users' entire friend lists on top of it. Those were people who never gave their consent in any way.
So yes, Facebook should have known better. The public backlash is warranted, and it's easy to understand why the hashtag #DeleteFacebook became a trend on Twitter beginning last spring.
But that campaign has not gained a whole lot of traction. Facebook's user growth slowed in the most recent quarter, but it still added 22 million daily active users worldwide.
There are still 1.47 billion people checking Facebook every day, and 2.5 billion use one of Facebook's apps every month.
Millions of people have found that their social lives revolve around Facebook. They use it to keep up with friends and family, local events they might want to attend, participate in groups that reflect their interests, and follow their favorite music artists, TV shows, and other content creators.
Many of them also use their Facebook profiles to log into third-party apps and sites, a more secure option than giving their email address and creating a password.
As Money Morning Defense and Tech Specialist Michael Robinson wrote in May, "Facebook is essential" for so many people. There's no other platform out there that can easily replace it.
That might sound like grounds for breaking it up, but that would defeat the purpose.
Social media is not like bottled water or televisions or cars. Facebook's value to users comes from the fact that it's where everybody is. Nobody wants Facebook to be separated into multiple different platforms. Which is why that won't happen.
It's also why Facebook has a chance to bounce back from this low point.
And it will bounce back, in a big way.
Why Facebook Will Emerge from This Crisis Stronger Than Ever
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Facebook is not the first company to face a major setback, and it wouldn't be the first to come back stronger from it, either...
- In 1878, a dust explosion leveled a six-story flour mill in Minneapolis. In response, the owner, Cadwallader Washburn, promptly built a bigger mill, this time implementing new safety measures that he shared with his competitors. The company would become General Mills Inc. (NYSE: GIS) and remains a name brand powerhouse over 100 years later.
- In 1904, the Baltimore headquarters of McCormick & Co. Inc.(NYSE: MKC) were destroyed in one of the worst urban fires in American history. But McCormick built a brand-new headquarters on the same site in just 10 months. Today it's a dividend aristocrat and dominates the global spice market.
- In 1982, seven people in Chicago were killed after taking Tylenol from bottles that had been tampered with. The manufacturer, Johnson & Johnson (NYSE: JNJ), decided to pull 31 million bottles - $100 million worth - off the shelves and to halt all production and advertisements. When the product went back onto shelves, it featured new, tamper-resistant packaging that would be emulated throughout the food and drug industries. Today, this is considered a model response to crisis, and JNJ is still going strong as one of the top blue-chip companies in the United States.
Facebook may have blundered its early response to its crisis. But the lack of serious competition to its product has given it the opportunity to find its way to the kind of response demonstrated by the companies above.
And the latest indications are that Zuckerberg's team is, in fact, figuring it out.
On July 31, the company announced that it had uncovered a coordinated misinformation campaign to influence the November mid-term elections, and that it had removed 32 pages and accounts connected to it. This week, we learned that it shut down another 652 pages, groups, and accounts linked to Russian and Iranian state groups.
The company has also made ad targeting more transparent. As of this summer, users have more access to find out why an ad was shown to them, and advertisers are required to disclose how they've obtained information about audiences that they upload into the system.
This last move didn't generate much publicity, but it's a huge deal. According to a 2016 survey by research firm Marketing Dive, 71% of consumers actually prefer targeted advertising to traditional broadcast advertising.
In other words, the issue is not ad targeting. The issue is transparency.
That's why it's worth the extra investment for Facebook to make its platform as safe and transparent as possible - while keeping its advertising mechanisms in place.
As Nick Thompson of Wired has argued, this extra investment doesn't mean Facebook will make less money, as many investors seem to assume. It means that it will make more money in the long term.
"You can actually sell more ads if people feel good about the product," Thompson says. "When people feel bad about the product, they're less likely to spend money on it."
Reviving General Mills, McCormick, and the Tylenol brand required major investments. But in every case, it was money well spent, and it paid off in spades. The demonstration by the companies that they were serious about making a good product and keeping their workers and customers safe made a lasting impression on the public.
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Of course, because of its virtual monopoly, Facebook could continue to drag its heels - and some will point out that the company hasn't been quick enough in implementing its changes. But there are strong reasons to believe that Facebook will continue to do what it takes to make this right.
First, Mark Zuckerberg cares about his product. By most accounts, he's not motivated much by Wall Street considerations. But he very much wants his products to be universally enjoyed, which means he will make the adjustments necessary to make that happen.
Second, his employees care. A big reason Facebook was able to lure many of the top software engineers in the business is not because of the pay - which they can get elsewhere - but because they believed it was an endeavor they could be proud to be a part of. The last thing those engineers want is to feel like they're working for the Evil Empire.
So if Facebook wants to hold on to its talent, it has no choice but to make significant changes - and that's what it's doing.
The Bottom Line: Now Is the Time to Buy Facebook
Again, Facebook's numbers look solid.
The Cambridge Analytica scandal managed to temporarily slow its user growth. But according to FactSet, earnings are still projected to increase 16% in 2018 and 70% by 2021.
If we look at the P/E ratio, the stock is trading at about 80% of its value. And if we use the price/earnings to growth ratio for the last 12 months, it's trading at just 60% of its fair value.
Those numbers suggest Facebook is undervalued and due for a rise of 25 to 66%.
But the numbers may be selling it short.
That's because the numbers don't know about all the changes Facebook is making. The numbers don't know how much Zuckerberg and his engineers want to make the best product they can possibly make.
And the numbers probably don't know about all the companies in the past that have used a crisis as a catalyst to come back better than ever, rewarding their shareholders handsomely along the way.
So you can buy Facebook based on the numbers or you can buy it for "big picture" reasons.
Either way, now is the time to buy Facebook.
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About the Author
Stephen Mack has been writing about economics and finance since 2011. He contributed material for the best-selling books Aftershock and The Aftershock Investor. He lives in Baltimore, Maryland.