Facebook's Q3: Growth Accelerates, News Feed Ads Hit Limit, and Teens Bail

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In somewhat of a roller-coaster ride, Facebook's shares jumped as much as 15% in after-hours trading when the company initially reported better-than-expected third-quarter results. But then gains were quickly (and completely) erased as management discussed the results during the earnings call. What happened?

First, let's dig into the numbers from the release. Facebook's top and bottom lines beat analyst expectations. Revenue was up 60% from the year-ago quarter at $2.02 billion, beating a consensus estimate of $1.91 billion. Non-GAAP EPS soared 108% to $0.25, beating a consensus estimate of $0.19. The outperformance was driven by 66% year-over-year growth in Facebook's advertising revenue (89% of total revenue).

Growth took center stage. Not only were Facebook's year-over-year growth rates in revenue and EPS enormous, but they also marked an acceleration of Facebook's second-quarter year-over-year growth in revenue and non-GAAP EPS of 53% and 58%, respectively. The company's huge user numbers also continued to grow. Monthly and daily active users reached 1,189 million and 728 million, respectively (compared to 1,155 million and 699 million in Q2).

Moreover, Facebook's mobile story continues to rapidly unfold. Mobile revenue accounted for a whopping 49% of Facebook's total revenue, up from 14% in the year-ago quarter and 41% in Q2.

It all sounds gravy, right? Unfortunately, there's a bleaker side to the story, too. A few comments in Facebook's third-quarter earnings call quickly turned investors sour on the rosy numbers.

Facebook's saturated teen membership
The first driver of uneasiness likely due to a comment from CFO David Ebersman: "[W]e did see a decrease in daily users specifically among younger teens." Ebersman continued: "We won't typically call out such granular data, especially when it's of questionable statistical significance given the lack of precision of our age estimates for younger users, but we wanted to share this with you now since we get a lot of questions about teens." As the first mention -- ever -- of a particular demographic (and an important one at that) cutting back usage on Facebook, it's certainly important to take note.

But should investors worry? At this point, it's nothing more than a rounding error. Ebersman reminded listeners during the earnings call that Facebook remains "close to fully penetrated among teens in the U.S." With close to full penetration, there will inevitably be volatility in teen daily active users, or DAUs. On the other hand, however, investors should keep an eye on the development next quarter to see if Facebook says the situation has worsened. Until then, the comments from management simply don't present a cause for concern.

Is 5% the magic number?
Ever wondered what percentage of the stories in your news feed are ads? It's a percentage that is "modestly higher" than 5%, according to Ebersman.

Ever wondered when Facebook will say enough is enough and stop adding ads to your News Feed? Well, Facebook may have finally reached that point. Ebersman said that investors should expect ads as a percentage of stories to not grow beyond where they are today. A number slightly higher than 5% apparently seems to be the magic number.

What kind of implications does this have on Facebook's business? Important ones, said Ebersman: "This is important because increasing ads in News Feed has been a meaningful driver of our revenue growth in 2013. So this should be factored into your expectations for next year." In other words, growth might not look as hot in the coming quarters.

Does this mean Facebook's growth story is over? Not at all. According to COO Sheryl Sandberg, increasing number of news feed ads per user is just one of two of the major factors driving Facebook's top line. The other two drivers she cited are the effectiveness of the ads and an increasing number of marketers. That said, investors probably shouldn't expect Facebook's year-over-year growth rates to continue accelerating. Even more, it might be wise to start expecting decelerating growth rates.

A pulse check
Bailing teens and an ad-packed News Feed aside, the fundamentals driving Facebook's business look as solid as ever. Bringing the earnings call back into the equation, however, investors can only speculate to what extent either issue will impact Facebook's future results. For all we know, the matter of young teens possibly bailing on Facebook may not even be an issue. And though we have been warned that Facebook's growth may not be as robust going forward, due to an ad-saturated News Feed, it's very difficult to estimate how quickly this growth could decelerate.

Fortunately, in the sport of investing, doing nothing is often the best action to take. While Wall Street wrestles over price targets and day traders scramble to speculate, Foolish investors in this game for the long haul can sit back and let the story develop. Facebook hasn't given investors any reason to sell, and Mr. Market hasn't provided an opportunity for prospective investors to buy -- and that's perfectly fine.

A smart social play
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The article Facebook's Q3: Growth Accelerates, News Feed Ads Hit Limit, and Teens Bail originally appeared on Fool.com.

Fool contributor Daniel Sparks owns shares of Apple. The Motley Fool recommends Apple and Facebook. The Motley Fool owns shares of Apple and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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