Is Facebook Stock Safe? What To Watch When They Report On Wednesday

Based on the performance of its stock over the past four weeks, it appears the worst may be over for Facebook. Shares have rallied approximately 10% from their 52-week low, having received a boost from Chief Executive Officer and founder, Mark Zuckerberg’s comments that the data breach fiasco related to Cambridge Analytica 'scraping' user information off the social media platform hasn't resulted in any meaningful number of users abandoning the platform.

Still, we don’t believe the issue is as simple as it seems. The number of Facebook users who might have removed themselves from the platform is hardly the only factor that will impact future profitability. The bigger hazard is how potential government regulations, along with Facebook’s own tightening of its privacy practices, will change the way users consume content on this platform. The critical consideration: will all this alter the embattled media giant's business model?

When Facebook ran its business without any impediments, its margins had analysts scratching their heads in astonishment as the company crushed expectations quarter after quarter, all the way back to its IPO in 2012.

In 2017, Facebook generated earnings from continuing operations of $15.9 billion on revenue of $40.7 billion, 98% of which came from advertising. Facebook’s gross margin was 87% last year, and its net income margin was 39%. To give some idea how successful Facebook has been in turning invested dollars into cash, digital ad rival Alphabet (NASDAQ:GOOGL), the parent of Google, didn’t even produce half of the margin Facebook handed investors last year.

Bottom Line

What should investors expect from the Facebook’s first-quarter earnings report later today? Some research firm surveys suggest there has been no major deterioration to user engagement. Facebook and Instagram, which Facebook owns, are still the dominant social media platforms. One view is that Facebook will report another strong quarter since advertisers are still locked-in. If users aren't leaving en masse, advertisers will continue to utilize the Facebook platform to sell their products and services.

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This is likely the key message Zuckerberg will try to deliver. However, what investors should really focus on are any details that highlight the cost and revenue impact of all the changes that Facebook is initiating in order to make the platform more secure and increase its acceptability to regulators.

That said, Mark Zuckerberg and company are still very capable of pulling off another strong quarter, once again beating The Street's consensus. However, we don’t think another blow-out quarter is going to be enough to erase the uncertainty currently hovering around Facebook shares.

The company is in the middle of a major transformation. Its practices are under investigation in multiple jurisdictions and there are quick fixes for any of these issues. It’s very tough right now to make a bull case for Facebook in 2018, particularly when we don’t yet know how any of these events will play out.