Why Facebook shows strong growth but the stock is still expensive (Part 2 of 5)
Facebook depends hugely on advertising revenue growth
In the previous article of this series, we discussed Facebook’s (FB) Q1 earnings and how its revenue growth of 72% was better than Wall Street expectations. In this article, we’ll discuss how Facebook managed to produce such strong growth. Facebook depends hugely on advertising revenues, and in Q1, advertising revenues contributed more than 90% to Facebook’s overall revenues. In Q1, Facebook’s revenues from advertisements was $2.27 billion, which showed a year-over-year growth of 82%. Interestingly, this year-over-year growth rate of 82% is Facebook’s strongest annual growth rate in nearly three years, even though the revenue base has also gone up.
News Feed ads have a higher associated price per ad
As the chart above shows, Facebook’s ad revenue growth is way ahead of Yahoo’s (YHOO), Google’s (GOOG), and LinkedIn’s (LNKD), while it only lags behind Twitter’s (TWTR). The main driver behind the growth in advertising revenues for Facebook was the 118% year-over-year increase in average effective price per ad displayed, even though total ad impressions declined 17%.
Facebook attributed the decrease in ad impressions to factors including the continued shift towards mobile use, where people are shown fewer ads compared to desktop. The increase in average price per ad was primarily driven by a mix shift, with more ads showing in News Feed. According to Facebook, News Feed ads have significantly higher engagement, click-through rates, and price per ad compared to right-hand column ads, so a higher proportion of ads appearing in News Feed drives up the overall average price per ad.
Facebook’s focusing on improving the relevance and quality of its ads
According to Facebook’s management, “Advertising and the ability to reach people more broadly is one of the most important technology platforms for achieving this, and we’re investing a lot to serve four major kinds of partners: small businesses, brands, developers and e-commerce partners. After introducing News Feed ads, which increased the supply of ads in our system, our recent efforts have primarily focused on improving the relevance and quality of these ads.”
Browse this series on Market Realist:
- Part 1 - Why Facebook shows strong growth but the stock is still expensive
- Part 3 - Why Facebook is helping advertisers grow their businesses
- Part 4 - Why Facebook managed to grow its operating margins
- Information Technology