A Financial Analysis of Facebook - Research Paper Example

A Financial Analysis of Facebook of the of the Table of Contents 0 Introduction 4 1 Background of the Research 4 1.2 Purpose of the Research 4 1.3 Research Question 4 1.4 Aims and Objectives of Research 4 2.0 Literature Review 5 2.1 Overview 5 2.2 Financial Conditions and Strategies 5 2.3 Analysis of Financial Ratios 6 2.4 Evaluation of Three-year Stock Price on Monthly Basis 7 2.5 Management of Currency Exchange Risk 8 2.6 Further Capital Market Consideration 8 3.0 Methodology 9 3.1 Research Objective 9 3.2 Research Design 9 3.3 Data Collection Instrument 9 3.4 Research Approach 10 3.5 Research Approach Adopted 10 4.0 Findings 10 5.0 Discussion 11 6.0 Limitation of Research 11 7.0 Conclusion and Recommendation 12 8.0 References 13 9.0 Appendices 15 9.1 Appendix 1 15 9.2 Appendix 2 16 9.3 Appendix 3 17 9.4 Appendix 4 17 9.5 Appendix 5 18 9.6 Appendix 6 18 1.0 Introduction 1.1 Background of the Research Facebook, Inc. is an online social networking service headquartered in California. It was founded in the year 2004 and comes under ‘internet’ industry (Bloomberg, 2015). As of March 2015, the company includes a total of 10,082 employees and having revenue of $12.46 billion as on December 2014 (Annual Report, 2014). Most of the revenues of the company come from advertising. It usually has a lower CTR (Click through rate) for advertisements as compared to other main websites. The reason for lower Click through rate of Facebook, Inc. has been accredited to the youngsters enabling the software of ad blocking and their expertise at ignoring the advertising messages. According to the iStrategy Labs report, 3 million fewer young generation customers or users were active on the Facebook in comparison to 2011. People are using Facebook in order to remain connected with family and friends, to explore what’s happening around the globe and to express and share what means importance to them or what matters them most (Facebook, 2015). 1.2 Purpose of the Research The main purpose of the research paper is to address the financial position and performance of the company by analyzing different ratios and its way of handling risk. The research design will include the secondary research method to gather the information. 1.3 Research Question The rationale behind this study is to explore how Facebook, Inc. has established itself in the market in terms of revenue. For this purpose, financial analysis will be carried out to answer the question in an appropriate way. 1.4 Aims and Objectives of Research To respond the question, following will be the aims and objectives of the research paper: To assess the financial condition of the Facebook, Inc. To discover the competitors of Facebook, Inc. To assess the strategies of the company. Ratio analysis will be carried out to recognize the financial position of Facebook, Inc. The reasons for the volatility of stock price will be explained through this research paper. To explain how the firm deal with its currency exchange risks. 2.0 Literature Review 2.1 Overview Facebook, Inc. functions as a social networking firm worldwide. It offers a set of tools as well as application programming interfaces which facilitate developers to amalgamate with Facebook in order to create web and mobile applications. The products of the company include website and mobile app, messenger and Instagram. These products allow individuals to collect, discover, share and interact with one another on personal computers and mobile devices (Bloomberg, 2015). The mission of Facebook, Inc. is to provide people with the authority to share, connect and to make the people around the world more open to each other. At present, its market share is 80.42; a low of 1.17% from the previous day (Yahoo Finance, 2015a). The main competitors are Google+ and Twitter (Marketrealist, 2014). 2.2 Financial Conditions and Strategies The WACC of Facebook, Inc. is 11.37% (See Appendix 1). It indicates that the company gives 11.37% on each dollar, which it finances or it may also be explained in this way that the company spend 11.37 cents on each dollar. So, it can be understood that on each dollar, Facebook, Inc. pays on an investment; they must make at least $1137 plus the price of investment. It will allow the investment to become feasible for Facebook, Inc. Analysis of WACC is significant because the securities analysts make use of WACC every time when selecting and valuing investments (Bierman, 2010). It has been observed that the profitability position of Facebook, Inc. is good. The profit as for the past three years shows that net income has been increased tremendously from 2012 to 2014. In the year 2012, the revenue was $5,089 million, which has increased to $12,466 million in 2014. At the same time, the new income has also increased from $53 million to $2,940 million. The diluted earnings per share (EPS) have revealed a great increase from $0.01 to $1.10 during the similar period (See Appendix 2). All these improvements indicate that the profitability position of Facebook, Inc. is very good (Annual Report, 2014). The dividend policy of Facebook, Inc. is such that they never paid or declared any type of cash dividend on their common stock. The company intends to keep hold of their future earnings as well as do not suppose to reimburse dividends in the near future. Moreover, their credit facility includes restrictions on their ability towards paying the dividends (Annual Report, 2014). The strategy and investment policy of the company are focused on the maintenance of capital as well as supporting their liquidity requirements. Their business strategies include making acquisitions in order to add dedicated employees as well as corresponding companies, technologies or products. For instance, in the year 2014, they paid $4.5 billion and issued approx 175 million shares of common stock in association with their acquisition/possession of WhatsApp. However, there is no guarantee that the company will get a good return on the investment for various acquisitions. It has been assumed that in the near future, Facebook, Inc. may have to incur debt or pay considerable quantity of cash to compensate for acquisitions. This could unenthusiastically affect their profitability position. The incurrence of the indebtedness may lead to increased expense of interest and augmented fixed obligation that would obstruct their ability to handle or manage their operations. However, there is no issuance of any corporate bond. 2.3 Analysis of Financial Ratios Net profit ratio: It is an effective tool which is used to evaluate the entire profitability of the organization (Rao, 2011). The net profit ratio of Facebook, Inc. is 14.45%, whereas that of industry average is 3.20% (See Appendix 3). It has been noticed that the ratio of the company is more than the industry average which represents that the company is efficiently managing its business operations. Long term debt to equity ratio: A high ratio generally signifies a great level of risk for the business (Lasher, 2013). The ratio of Facebook, Inc is 0.07 (See Appendix 3), which is very less than the ratio of industry average i.e. 86.86 (Yahoo, 2015). It indicates that the company is less risky and they have more equity than the liabilities. Therefore, it represents the good financial position of Facebook, Inc. Market capitalization: It is defined as the market value of issued share capital of a company. Companies or organizations are ranked on the basis of small-cap, mid-cap and large cap according to their market capitalization (Financial Times, 2015). The market capitalization of Facebook, Inc. comes under large cap because it is more than $200. The market capitalization of industry average is 86.7 billion (Yahoo, 2015), whereas that of Facebook, Inc. is 226.96 billion (Yahoo Finance, 2015a). The categorization of the companies into separate caps facilitates investors to find out the risk versus growth potential of the company (Financial Times, 2015). It has been observed that the market capitalization of Facebook, Inc. is more than the industry average and also it comes under the large caps (See Appendix 3). So, it represents the good financial position of the company and it has also been analyzed that it will face slow growth but there will be a low risk associated with it. 2.4 Evaluation of Three-year Stock Price on Monthly Basis The stock price of Facebook, Inc. is evaluated for the period of three years on monthly basis. During May 2012 to May 2013, a huge volatility has been observed in the share price of the company. In May 2012, the share price was 42.05, which has reached its lowest at 18.08 in September 2012. However, it has recovered to some extent and was recorded at 27.85 in May 2013 (Yahoo Finance, 2015b) (See Appendix 4). Most of the revenues of the company come from advertising. So, the reason for the huge volatility may be the lower click through rate for advertisements as compared to other main websites. The reason for lower click through rate of Facebook, Inc. has been accredited to the youngsters of their expertise at ignoring the advertising messages (Facebook, 2015). Due to this reason, Facebook, Inc. has generated less revenue in 2012 and therefore the investors also shows less interest to buy the shares of this company. During May 2013 to May 2014 a great improvement has been noticed in its stock price. It has increased from 26.18 to 60.46 in May 2014 and thus it represents a rising trend continuously (See Appendix 5). The reason for the continuous increase in the stock price is the increased revenue, net profit and shareholder’s equity of the company. Due to these reason, the investor shows great interest to invest in Facebook, Inc. and it helps to raise the stock price of the company. During May 2014 to May 2015, the stock price of the company rose to a great extent (See Appendix 6). It has also showed an increasing trend. In the year end i.e. December 2014, the share price was 77.26 which has increased to 79.24 in May 2015 and has further increased to 80.42 (Yahoo Finance, 2015a). The improvement in the stock price may be due to the reason of acquisition of WhatsApp. In the year 2014, Facebook, Inc. paid $4.5 billion and issued approx 175 million shares of WhatsApp. This acquisition proves to be effective and resulted in the augmented share price of the company. Moreover, the reviews of the users may also help to give good rating to the Facebook page. All these factors might have encouraged investors to buy share of this company and thus the stock price of Facebook, Inc. have increased to a great level. 2.5 Management of Currency Exchange Risk Facebook, Inc. encompasses currency exchange risk associated to their operating expenses and revenues denominated in currencies excluding the US dollar, mainly the Euro. The company is a net recipient of the currencies and therefore the changes in the exchange rates will unenthusiastically affect their operating expenses and revenues. They have also experienced some fluctuations in their net income because of transaction losses and gains connected to revaluing definite current liability and current asset balances, which are denominated in the currencies. Furthermore, the company has recognized losses of foreign currency of $9 million, $14 million and $87 million in 2012, 2013 and 2014 (Annual Report, 2014). Facebook, Inc. can either hedge their currency exchange risk through financial hedging or natural hedging. By means of natural hedging, they can reduce the variation between payments and receipts in a known foreign currency. Other option is forward contracts, which comes under financial hedging. Through forward contracts, Facebook, Inc. can set the rate of exchange at which they will sell or buy the specific quantity of the foreign currency possibly in the near future. It is a flexible instrument, which can simply match exposures of future transactions and therefore will help the company to manage its currency exchange risk in an efficient way (Homaifar, 2004). 2.6 Further Capital Market Consideration Facebook, Inc. may need additional capital in order to support their business growth and also to respond towards their business challenges, opportunities as well as unforeseen circumstances. Their capability to obtain additional capital will depend on their investor demand, business plans, capital market conditions and their operating performance (Annual Report, 2014). 3.0 Methodology 3.1 Research Objective The objective of the research paper is to show the financial position and performance of the company by analyzing financial conditions and strategies, different ratios, evaluation of stock price and its way of handling risk. 3.2 Research Design The paper is designed mainly to show the position of Facebook, Inc. in the market by means of financial analysis. Therefore, the research has been carried out on the ratios, strategies, financial conditions, profitability positions, dividend policy, three years stock price evaluation on monthly basis and on the risk management system of Facebook, Inc. by means of secondary research. Primary research has not been carried out because it was not possible to communicate the management of Facebook, Inc. in order to explore the financial performance of the company. Therefore, financial analysis has been done through secondary research only. 3.3 Data Collection Instrument The two types of data collection instruments are the primary and secondary research instruments. Method of primary research: Generally the primary research is carried out by taking the sample size of the respondents. It engages quantitative methods which rely on structured data gathering instrument as well as on the method of sampling that fit mixed experiences into prearranged response categories. The outcomes which are generated through these methods are simple to contrast, summarize and generalize. The method of primary research includes face-to-face and telephonic interviews based on the arranged questionnaire by the researcher. The advantage is that it is specific to the requirements of researcher and the drawback of this method is that it usually costs more as well as takes very long time to complete the entire process (Gratton & Jones, 2004). Method of secondary research: Secondary sources comprise of public sources, educational institutions and commercial sources. Commercial sources are valuable but also expensive because it involves association fees and subscription. Public sources are usually free and present valuable information as well as incorporate government and business departments. The main advantages of conducting secondary research are that it is inexpensive in comparison to the primary research and also offers quick result by engaging less span of time (Gratton & Jones, 2004). 3.4 Research Approach Inductive approach: It entails the inspection of actions and the links between the variables and also the finding of any trend within the relationship. When these activities are finished or accomplished, the researcher is capable to arrive at a position from where a thorough conclusion is presented. Inductive approach assists in the conversion of observation into well-built conclusion. Its strength lies in knowing the viewpoint within which research occur and not emphasizing on a relationship of reason-and-effect. The researchers test the soundness of the theory which has been developed with the help of literature in order to express the connection between the research variables (Nestor & Schutt, 2014). Deductive approach: It starts with the development of valid theories and can be described by means of certain propositions, which is obtained from theories. It assists the researcher to test the consistency of the statement in a manner contrary to that of inductive approach. Deductive approach aids to develop hypothesis by relying on existing theories. The performance among the research variables which gives shape to the research surroundings is studied under this approach. It is based on common or universal ideas in order to reach at particular situation as well as it is linked with positive paradigm (Nestor & Schutt, 2014). 3.5 Research Approach Adopted Inductive approach has been deemed appropriate in order to conduct this research study. The main rationale behind the adoption of this approach is that during early stage of the research, generalized issues has been discussed, which are related to the research topic. Thereafter, emphasis is put on specific dimensions and aspects of the research topic. By adopting this approach, the researcher has been largely successful in inferring results and translating them into evidence oriented conclusion (Nestor & Schutt, 2014). 4.0 Findings The findings have been drawn with the help of the secondary research. Financial analysis on Facebook, Inc. has been carried out to explore how the company has positioned itself in the market in terms of revenue, net profit and market capitalization. It has been analyzed that main competitors are Google+ and Twitter and there are also some unlisted companies like Snapchat, Myspace, Flickr and Pinterest, who are their competitors. The WACC of Facebook, Inc. is 11.37% which indicates that the company gives 11.37% on each dollar, which it finances. It has been observed that the profitability position of Facebook, Inc. is good because the profit as for the past three years shows that net income has been increased enormously from 2012 to 2014. The net profit ratio of the company is more than the industry average, which indicates that they are efficiently managing their business operations (See Appendix 3). The long term debt to equity ratio is less than the industry average which indicates that Facebook, Inc. is less risky. Moreover, the market capitalization of Facebook, Inc. is more than the industry average, thereby indicating good financial position of the company. Overall, it has been discovered that the company is performing well in the market. 5.0 Discussion Doing financial analysis is very important because it involves examining the historical facts in order to collect information about the present as well as future financial position of the organization or company. It has been analyzed that the company never paid or declared any type of cash dividend on their common stock. Their business strategies of Facebook, Inc. include making acquisitions in order to add dedicated employees as well as technologies and products of different companies. After the acquisition of WhatsApp, they have experienced increase in the revenue and net profit. The share price of the company has also increased to a great extent. It has been assumed by the company itself that in the near future, they may have to incur debt to compensate for acquisitions. The monthly stock price evaluation indicates that the company was not doing well from May 2012 to 2013, but after that great increase in its share price had been noticed due to the increased revenue, net profit and shareholder’s equity. As soon as Facebook, Inc. has acquired WhatsApp, its share price increased to a great extent and recorded at 80.42 in May 2015 (Yahoo Finance, 2015a). 6.0 Limitation of Research One of the main limitations of the applied research design is that there is no incorporation of primary research. As no surveys and interview was conducted so there is no means to verify the reliability of the information that is acquired from the empirical researches. Moreover, the research does not involve any form of quantitative analysis, which restricts the way to explain the research findings in detail. If the primary research could have been carried out then it would help to provide more exact picture of the financial performance and position of Facebook, Inc. 7.0 Conclusion and Recommendation The research paper has been designed to provide the financial position of Facebook, Inc. by conducting ratio analysis, analyzing strategies and financial conditions, evaluating the reason for the fluctuation in stock price and also by analyzing how the company handles its currency exchange risks. Facebook, Inc. can either hedge their currency exchange risk through financial hedging or natural hedging. The stock price evaluation shows that the company is not performing well in 2012, but after May 2013, its share price has shown a continuous increase and resulted in increased revenue, shareholder’s equity, net profit and market capitalization. As a whole, the financial analysis of Facebook, Inc. indicates that the company is less risky and is efficiently managing its business operations. As the company is doing well in all aspects, so it is recommended that they should continue their operation in this way only to enjoy elevated revenue and profits. They should pay more attention towards the hedging of different risk as they are already exposed to currency exchange risks. It is also suggested that the investors should buy the shares of Facebook, Inc. because of its good financial performance and position in the market. 8.0 References Annual Report. (2014). Facebook, Inc. Form 10-K Annual Report. Retrieved from http://investor.fb.com/secfiling.cfm?filingID=1326801-15-6. Bierman, H. (2010). An Introduction to Accounting and Managerial Finance: A merger of equals. New Jersey: World Scientific Publishing Co. Pvt. Ltd. Bloomberg. (2015). Company Overview. Retrieved from http://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=2076546 3. Facebook. (2015). Facebook: Investor Relations. Retrieved from http://investor.fb.com/. Financial Times. (2015). Definition of Market Capitalization. Retrieved from http://lexicon.ft.com/Term?term=market-capitalisation. Gratton, C., & Jones, I. (2004). Research methods for sport studies. London: Psychology Press. Homaifar, G. (2004). Managing global financial and foreign exchange rate risk. New Jersey: John Wiley & Sons. Lasher, W.R. (2013). Practical Financial Management. Boston: Cengage Learning. Marketrealist. (2015). Why Facebook is a leading social media player. Retrieved from http://marketrealist.com/2014/01/facebook/. Nestor, P.G., & Schutt, R.K. (2014). Research methods in Psychology. California: SAGE Publication. Rao, P.M. (2011). Financial Statement Analysis and Reporting. New Delhi: PHI Learning Pvt. Ltd. Stockresearching. (2013). Facebook, Inc.: Fundamental Analysis WACC, Cost of Debt and Cost of Equity $FB. Retrieved from http://www.stockresearching.com/2013/12/23/facebook-inc-fundamental-analysis- wacc-cost-of-debt-and-cost-of-equity-fb/. Yahoo. (2015). Industry Browser – Technology Sector – Industry List. Retrieved from https://biz.yahoo.com/p/8peeu.html. Yahoo Finance. (2015a). Facebook, Inc. Retrieved from http://finance.yahoo.com/q?s=FB. Yahoo Finance. (2015b). Facebook, Inc. Retrieved from http://finance.yahoo.com/q/hp?s=FB&a=04&b=18&c=2012&d=04&e=18&f=2013& g=m. 9.0 Appendices 9.1 Appendix 1 Calculation of WACC (Source: Stockresearching, 2013) 9.2 Appendix 2 (Source: Annual Report, 2014) 9.3 Appendix 3 Facebook, Inc. Ratios Formula 2015 Industry Average Profitability Ratio Net Profit 512 Sales 3543 Net Profit ratio (Net profit/sales)*100 14.45 3.20% Long term Debt 2647 Equity 37501 Long term Debt to Equity (Long term debt/ Equity) 0.07 86.86 Market Capitalization 226.96 B 86.7 B (Source: Author’s Creation) 9.4 Appendix 4 Stock price of Facebook, Inc. from May 2012 to May 2013 (Source: Author’s Creation) 9.5 Appendix 5 Stock price of Facebook, Inc. from May 2013 to May 2014 (Source: Author’s Creation) 9.6 Appendix 6 Stock price of Facebook, Inc. from May 2014 to May 2015 (Source: Author’s Creation) Read More