The Next Blue Chip Stocks: Facebook

Image: Sean MacEntee, Flickr.

If you're on the lookout for the next blue chip stock, give Facebook Inc. some consideration. There's no standard definition for blue chips, but Facebook certainly meets some of the criteria many people would suggest. Let's run the company through a few of them and see how it fares.

Track record of performance over time

First off, Facebook is a young company, founded only a decade ago, in 2004, and it's been public for less than three years. It therefore doesn't have the longest track record, but it already boasts a market capitalization of about $200 billion, greater than that of venerable giants across many industries such as Coca-Cola, Toyota Motors, AT&T, and Bank of America. You don't reach such a size and end up in such company without having done a lot of things right.

Here are some eye-popping numbers from  the company itself:

  • 829 million daily active users on average in June 2014.
  • 654 million mobile daily active users on average in June 2014.
  • 1.32 billion monthly active users as of June 30, 2014.
  • 1.07 billion mobile monthly active users as of June 30, 2014.
  • Approximately 81.7% of daily active users outside the U.S. and Canada.

Not many companies have more than a billion customers! It's noteworthy that Facebook also has more than a billion mobile users, too, reflecting a very effective move into that fast-growing platform. (The count of mobile users jumped 31% in just one year.)

Solid balance sheet

Facebook's balance sheet is quite solid, with cash short-term investments growing more than sixfold over three years, shareholder equity growing seven-fold and no long-term debt.

The company's goodwill has been growing, too, more than 20-fold, and that's due to acquisitions made at prices over intrinsic value. It's common for an acquisition to feature a premium, but when Facebook bought the cross-platform messaging app WhatsApp for $19 billion, lots of eyebrows rose, as many saw the price as quite excessive. Interestingly, Facebook has spent more than $22 billion buying a bunch of companies in the past six years (including Instagram), and the WhatsApp purchase makes up most of that. Only time will tell whether Facebook was crazy to pay such a price. And even if it was, a blunder here or there doesn't disqualify a would-be blue chip. Just ask Coca-Cola about Classic Coke.

Mobile ad revenue is powering Facebook's growth.
Data for image retrieved from Facebook quarterly SEC filings. 

Strong revenue growth and cash flow generation

To say that Facebook's revenue and earnings are growing briskly would be an understatement. In its young life, revenue has quintupled since 2010, while net income nearly quadrupled. Better still, profit margins are up, and free cash flow tops $3 billion.

What's Facebook doing to generate so much on its top and bottom lines? It's selling a lot of advertising -- increasingly on its mobile platform. In its last quarter, revenue surged 61% year over year, while earnings soared 121%, benefiting strongly from sales of mobile ads. Mobile ads made up 62% of total ad revenue, up from 41% last year.

The company has a lot more going on, too. It recently bought the virtual reality headgear maker Oculus and is working on monetizing Instagram. It has started running video ads and is delivering a billion per day or more.

There are even rumors that Facebook is aiming to take on LinkedIn with a competing offering being referred to as "FB@work." It's not smart to make investment decisions based on rumors, but this initiative, or ones like it, are not so far-fetched, given Facebook's enormous reach. International expansion is another growth driver, and its WhatsApp purchase helps there, as it has many African users.

Source: Facebook's Facebook page.


And now we come to dividends, as typical blue chip stocks offer them. Facebook doesn't, though, and few are holding their breath for a monthly payout. That's because young and rapidly growing companies tend to need to plow their excess cash back into the business, fueling further growth. Once they start running out of other ways to use their cash, and once management feels confident it can consistently afford a dividend payout, a dividend may be initiated.

Shareholders aren't out of luck, though. Along with stock-price appreciation, Facebook can still reward them via share buybacks, without committing to a dividend. It essentially did so in 2012, when its shares had fallen from their IPO levels. The share price has more than doubled since then, reflecting a savvy move.

Yea or nay?

Some dictionary definitions for the term "blue chip" are that the stock be of the highest quality and reliable. In other words, investments in blue chip stocks should help you sleep at night. Despite all that Facebook has accomplished, and all its potential, it fails on this last metric. It's operating in an environment that moves too fast, and its future is far from certain, though its main competitive advantage, the sheer scale of its vast network, is formidable.

This is a company that risk-takers should consider investing in, while those seeking more stable blue chip stocks might want to at least keep an eye on its progress.

Want dividends? Facebook offers none, but here are some big payouts.
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Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter, owns shares of Coca-Cola and LinkedIn. The Motley Fool recommends Bank of America, Coca-Cola, Facebook, and LinkedIn; owns shares of Bank of America, Facebook, and LinkedIn; and has options on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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