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Facebook is Bulletproof When it Comes to Bad News

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In March 2018, Facebook (FB - Free Report) was facing what threatened to be a major crisis of public opinion. The company had already been identified as a vehicle of Russian interference in the 2016 election and then the FTC confirmed that it opened an investigation into the company’s privacy policies and protection of user data in the wake of the Cambridge Analytica scandal.

The stock traded down more than 7% in a single day, coming on top of a nearly 14% decline in the previous week.  Almost simultaneously, it was also revealed that Facebook had improperly accessed some phone and text message data from users who used the Facebook mobile app on Android phones.  

Public outcry was swift and severe. Celebrities publicly announced that they were going to stop using Facebook. A twitter hashtag - #deletefacebook - defined a movement that threatened to become a mass-exodus of users. Founder and CEO Mark Zuckerberg was called to testify before congress about Facebook’s use of data and its efforts to protect user privacy. It looked like a multi-faceted PR disaster.

Technically, the stock experienced the dreaded “death cross” with the 50-day moving average crossing the 200-day moving average to the downside in early April.

What happened to the stock price after that?

It has rallied 37% since hitting 52-week lows on March 27th. The news-induced dip proved to be a huge buying opportunity.

In the meantime, Zuckerberg was grilled by congress and offered a huge mea culpa and a promise to protect user privacy and tighten data policies. CTO Mike Schroepfer got basically the same treatment in front of UK Parliament. The company has been forced to simultaneously defend itself against claims both of allowing “fake news” and also of censorship. Most recently, Zuckerberg has found himself defending comments he made in an interview which some people considered sympathetic to holocaust deniers.

So how does Facebook stock continue to rally no matter how bad the headlines are?

Because it’s a cash generation machine.

Immediately following the Cambridge Analytica scandal, Facebook reported a blowout Q1, topping analyst earnings estimates by 24% - the company’s 11th quarterly beat in a row. Revenues increased 49% over Q1 2017, while total expenses grew only 39%, boosting operating margin from 41% to 46%.

Importantly, Facebook also reported year-over-year increases in daily and monthly active users of 13% each, indicating that fears of a user exodus were overblown.

Facebook is scheduled to report Q2 results on July 25th and the Zacks Consensus estimate is for earnings of $1.75/share, up from $1.62/share 90 days ago and a 33% increase over Q2 2017.  Facebook is a Zacks Rank #2 (Buy).

One thing institutional investors love about Facebook - and that allows the stock to weather these storms - is that it has become a huge generator of free cash flow. With operating cash flows growing much faster than expenditures, the company has $44B of cash and equivalents on hand to expand and develop new products and services and also to buy back shares.

Even as the shares have risen over the past 3 years, free cash flow has risen even faster, and the ratio of price/free cash flow - while off the lows made in March - is still well under its historical average.

The takeaway here is that the news can sometimes be misleading. Short-term traders might buy or sell based on headlines. Long-term investors understand the finances of the businesses they follow and can recognize a money-making juggernaut like Facebook ought to be largely immune to the news cycle over time.

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