Why Facebook is a Fisher Stock

 

"I have already made up my mind, don't confuse me with facts." - Philip Fisher 

 

Security analysis seems to be the buzz word of the day - or perhaps the buzz word of the century when it comes to investing like the pros. Why is it that so many investors (if we can call them that) find themselves buying into a company at one point and selling at another, just to find themselves repeating the process over and over again as the same stock climbs higher and higher?

The answer is simple: lack of proper security analysis.

After dropping out of Stanford Graduate School of Business in 1928, Philip Fisher started his career as a securities analyst with the Anglo-London Bank in San Francisco. Shortly after, he started his own money management fund in 1931, Fisher & Co., and would go on to become one of the most famous investors of all time, influencing the likes of Warren Buffett who claimed himself to be 15% Philip Fisher (the remaining 85% would be attributed to his mentor Benjamin Graham, the founder of the term and author of the book, Security Analysis, 1940).

However, what Philip Fisher is most widely recognized for is his authorship of Common Stocks and Uncommon Profits. In this classic on investing, Fisher lays out his Fifteen Points to recognizing a bonanza company. These guidelines are essential when analyzing the potential of a business for not only the near-term, but the long haul as well. It is a safe bet that if a company matches most of the fifteen points (while not all being necessary), the company is a bonanza stock, indeed.

 

Fifteen Points:

1.

• Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.
  

 

Taking Facebook (FB) into question, it is important to understand how the company creates revenue. Contrary to popular belief, Facebook's users are not the company's consumers, but rather its products. Provided with unique target audiences, advertisement companies act as the consumers, each competing for ad space.

With that said, Facebook is well on it's route to obtaining over 1.7 billion users (roughly more than half of the world's internet-enabled population) and has continued to increase its user base at astounding rates, providing ad companies with well over several years before any slowdown in ad revenue precipitates. Furthermore, Facebook has continued to evolve as a platform, continuously making major changes quarter to quarter, creating one of the most beautiful and elegant platforms helping to shape globalization today. An example of some of the changes and statistics from Q1 2016 are illustrated below:

2.

• Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.

(ten-year roadmap, Facebook F8 Conference)

Along with the numerous advantages of having acquired Instagram and WhatsApp - these platforms are growing at astronomical rates. After Facebook eventually begins to saturate its global user growth, there should be little cause for concern as Instagram alone has grown by over 100 million users in the past three months (Q2), alone (>500 million users total). Instagram has grown at a much faster rate than Facebook did when it had only 500 million users, and when it comes to optimizing the monetization process, Instagram and WhatsApp have not even started.

Additionally, in 2013, Facebook launched Internet.org - a way to connect the 4.2 billion people who do not have access to internet with Free Basics (news, health information, and services such as Facebook, Wikipedia, Google Search, and AccuWeather) brought via drones deploying wifi to remote regions. Today, Free Basics is live in more than 40 countries, more than half of which are in Africa. For countries previously without access to basic information, this is perhaps the biggest shift in technology since the Industrial Revolution. 

 

Finally, Oculus (a virtual reality company under Facebook's umbrella) has ramped up its production and technology efforts in the past few quarters, significantly. The evidence is clear as Facebook rolled out "360-degree video" on its main platform - just another way to increase its user engagement with advertisements showing 360-degree videos of stunt men jumping out of airplanes, etc. - all increasing the price of ad space on its platform - without relying on user growth.

 

3.

• How effective are the company's research-and-development efforts in relation to its size? To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective. 

 

Fisher notes that many analysts attempt to provide a figure for the amount of dollars made in sales per dollars spent on R&D, and subsequently compare it to the industry average. However, this method may reveal rather misleading, as some companies may include expenses on R&D that others do not. This common practice is called salesengineering.

Still, while finding an exact multiple may prove somewhat arbitrary, Fisher argues that if research expenditures are to attain maximum efficiency, there is one major requirement: coordination with top management, or rather "top management's understanding of the fundamental nature of commercial research."

There is a tendency for larger corporations to interrupt regular research projects with crash programs (programs which are abruptly abandoned in order to attain immediate goals). However, great management can recognize alternative uses for innovations arising out of completely separate original goals. Facebook's prime example of this can be seen with Oculus' 360-degree video, as mentioned above. While original R&D had planned on producing virtual reality gaming devices, the company is already exploring alternative uses for the technology. Such uses include production of 360-degree movies (Jungle Book), as well as 360-degree video advertisements on the Facebook platform.

4.

• Does the company have an above-average sales organization? Few companies are so outstanding that they will sell to their maximum potentialities if they are not expertly merchandised.

 

Fisher describes that outstanding production, sales and research may provide the three columns necessary for success, but like the organs of the body, one alone cannot be deemed sufficient. Facebook's team often seeks out young talent, offering jobs via hacker competitions, leading to talent which has helped yield massive increases in sales year after year:

5.

• Does the company have a worthwhile profit margin?

 

Fisher emphasizes that profit margins are important to attaining annual profit growth. It is thus important to determine the number of cents of each dollar of sales that is brought down to operating profit. Such a study, he argues, should be made for a series of years. 

While Facebook's operating profit margins have been relatively stagnant over the past five years, they average out at 33.66% - higher in comparison to both Google's average of 26.11% and Amazon's slight margin of 1.24%. With Facebook's rapidly growing sales, new products and services, and top tier management, outlook for Facebook's annual operating profit margin growth looks bright.

6.

• What is the company doing to maintain or improve profit margins?

  

"The success of a stock purchase does not depend on what is generally known about a company at the time the purchase is made. Rather it depends upon what gets to be known about it after the stock has been bought."

One interesting point that Fisher makes is that most companies have to worry about the trend of tax rates, particularly real estate and seemingly steadily

increasing local tax rates. Essentially, different companies are going to have different results in the trend of their profit margins. Some companies can maintain and even increase their profit margins simply by raising prices; however, while this may work temporarily, over time this strategy may prove futile for the long-range investor. Instead, improving profit margins by far more ingenious means such as product-engineering departments and continuing know-how from the managers who built up the organization is typically most profitable for the long-range investor.

7.

• Does the company have outstanding labor and personnel relations? 

As Fisher explains, profits made by having happy employees are overwhelmingly overlooked by investors. Few investors fail to recognize just how bad the impact of having bad labor relations truly is. "The effect on production of frequent and prolonged strikes is obvious to anyone making even the most cursory review of corporate financial statements."

Nevertheless, Facebook ranked no. 5 in Glassdoor's Employees Choice Awards 2016, ahead of Google. Facebook continues to be one of the most sought after companies by millennial graduates. Even Wall Street has begun to take notice, raising junior bankers wages by 20-25%, under pressure from companies like Facebook and Google.

Some of the benefits of being a Facebook employee are:

1. New Parent Benefits: $7000 in baby and baby sitter expenses as well as 4-months paid time off (even for fathers).
2. Vacation: 21-days of paid vacation and "unlimited" sick days.
3. Food: Free meals all-day long.
4. Healthcare: 100% healthcare paid for by the company.
5. The Little Things: "Work From Home Wednesdays," $700 gym memberships, ice cream socials, regular non-executive meetings with the CEO, and the Silicon Valley atmosphere - along with the people in it.

8.

• Does the company have outstanding executive relations? If having relations with lower echelon personnel is important, creating the right atmosphere among executive personnel is vital.

 

Factors important to executive relations cover a broad spectrum ranging from salary adjustments related to merit, to respect from lower level employees of higher level management. Relating back to the central theme of exceptional management at Facebook, employees highly respect executive management as emphasized by the demand for jobs at Facebook. Additionally, management executives get paid handsomely via stock options. Mark Zuckerberg, however, maintains his $1 per year salary (not including his stock ownership of $24 billion).

9.

• Does the company have depth to its management?

 

While Mark Zuckerberg may be the captain of Facebook's ship, COO Sheryl Sandberg does not fall far behind. Not only is Sandberg a leader in technology, but she is also an author, activist and a 2012 top 100 most influential people awardee by Time Magazine. A leader in the business world, Facebook attains depth of talent unseen in the rest of the industry. 

 

10.

• How good are the company's cost analysis and accounting controls?

  

As Fisher notes: "No company is going to continue to have outstanding success for a long period of time if it cannot break down its over-all costs with sufficient accuracy and detail to show the cost of each small step in its operation." Moreover, he goes on to detail that it is often only in instances of extreme inefficiency that the careful investor will get a clear picture of the status of cost accounting and related activities in a company in which he is contemplating investment. "The best that the careful investor usually can do in this field is to recognize both the importance of the subject and his own limitation in making a worthwhile appraisal of it."

11.

• Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

 

With regards to this point, it is important to note the direction of technology since the start of the 21st century. Ever since Apple introduced the iPhone (as well as the iPad), everything from newspapers to every day computing has shifted to mobile. When Facebook made its IPO, mobile advertising was not even considered in its valuation. However, just four years later, mobile advertising makes up over 77% of its total ad revenue. Facebook's ability to adapt to its ever-changing environment has proven exceptional among the industry.

Moreover, users are subscribing to other services via "Sign Up Through Facebook" registration buttons. This has enabled Facebook to gather even more data per user, simply increasing the price per ad.

Nevertheless, Facebook is still expanding and yet to optimize monetization of WhatsApp and Instagram's combined 1.5 billion users.

12.

• Does the company have short-range or long-range outlook in regard to profits?

 

As shown above, Facebook's CEO has told investors on numerous occasions to maintain patience in the years ahead as the company has a long-range outlook. This is evident in Zuckerberg's patience to begin the monetization process while the products under his umbrella gain maximum user expansion. Additionally, in 2014, Mark Zuckerberg gave a speech in China, where he spoke Mandarin for his introduction. While his Mandarin was clearly at the beginner level, he received a roaring response. Since Facebook is currently blocked in China, small acts like these simply imply a long-range outlook when regarding forged ties with a country that holds 20% of the world's population. 

13.

• In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth?

 

With regards to the strength of Facebook's financial positioning, there is genuine stability at this point in time, as the company has seen continued annual growth in cash and cash equivalents and has virtually zero long term debt.

14.

• Does the management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur?

 

The most telling reference for Facebook's Mark Zuckerberg in regards to this point is when allegations were brought forth accusing Facebook of suppressing conservative views in its TrendingTopics section. Responding to the claim, Mark Zuckerberg immediately underwent an internal investigation into the Trending Topics team at Facebook. Shortly after, he released an apology letter to the public on his own behalf promising to have his team undergo an additional training course in bias reduction. Honesty is an integral quality in executive management, and Facebook's management has been honest through not just the good times, but the bad as well.

15.

• Does thecompany have a management of unquestionable integrity? 

  

Regarding this point, Fisher alludes to management overcompensation. At Facebook, it is important to emphasize again that Mark Zuckerberg's annual salary is $1. This places roughly his entire net worth into the stock performance of his own company. Other CEOs who also acquired a $1 annual salary included the noteworthy Steve Jobs (Apple) and Larry Page & Sergey Brin (Google).  

 

Simply put, Facebook is a Fisher Stock and lifetime investment.

_______________ 

Ben Koeppel is a MSc Management Science candidate at the London School of Economics and Political Science. He attained his BA in Economics at the University of Miami (FL). Ben can be reached at (504) 430-6450 or email: [email protected].