Facebook's Stock Is Closing In On $50 - Here Is What's Driving It Higher

Facebook's stock price is closing in on $50. It was up 4.2% this morning to just above $49.

And Citi just issued a report giving the stock a target price of $55 per share.

A year ago, this situation would have been unthinkable. Facebook launched at $38/share and promptly tanked, flirting with just $17 back in 2012. When I bought $1,000 of Facebook stock last June at just over $31, a lot of readers laughed. They continued laughing as I lost nearly half my stake on paper.

So why has everyone suddenly come round?

There are a bunch of things going on at Facebook, and it's a complicated company that is sometimes difficult to understand. But here's my reading of why investors are suddenly so bullish about a company they hated a year ago.

Basically, it's about what Facebook has not yet done, that is enticing investors.

Since going public, Facebook has added on some fairly basic advertising formats for advertisers. They're all (conceptually) simple products that have been available on competing web sites for years: There are the equivalent of web display ads, and there's an ad exchange ("FBX") for buyers who want "programmatic" or real-time bidding on users who come in from other sites carrying cookies than can be retargeted with new ads.

These "simple" products added $700 million in revenues in Q2 2013, and Facebook now books $1.8 billion in revenue every quarter.

That's just from the low-hanging fruit, the stuff that everyone understands.

Facebook has also added some complicated "Big Data" marketing products via partnerships with the consumer market research firms Datalogix and Axciom. In those "custom audience" products, advertisers can match their own email or phone lists versus Facebook's, and see the difference in the success of their ad campaigns targeted that way. Facebook has a partnership with Nielsen, too, that helps advertisers figure out how well their ad dollars are driving sales. Note that TV companies don't have these products.

We don't have very good visibility on how successful Facebook's Big Data efforts have been. But COO Sheryl Sandberg gave a clue on the Q2 2013 conference call. She said, "We've made a major investment in helping DR marketers measure returns. ... their budgets are flexible around ROI. ... They adjust to their budgets."

To translate: DR stands for "direct response." It refers to companies who spend, for instance, $50,000 on Facebook ads and then wait to see what that generates in sales. If it generates, say, $100,000 in sales, then the advertiser will spend another $50,000 or more, and recalculate. The spend is driven by the sales results, and as long as sales continues to go up so does ad spending on Facebook. It's gritty, unglamorous stuff - but it's the guts of the e-commerce business.

It's important to understand that, because the advertising you see a lot of isn't hooked to DR spending. "Brand" or corporate image advertising - the stuff that makes you smile when you watch the Super Bowl - tends to have a fixed budget that is set once a year at most companies, regardless of how successful it is. Facebook has simply decided that it is going to take the DR money, not so much the brand money, because if you can demonstrate that sales follow then DR spend rises quickly.

So that's the current growth story at Facebook.

Now look at what the company has planned for the future, revenue streams it hasn't yet gotten a grip on:

• Video advertising
• Instagram advertising
• Mobile advertising inside the FBX exchange.
• Graph search advertising
• Paypal style payments
• E-commerce
• Off-Facebook advertising using the Atlas ad server Facebook acquired from Microsoft
• Off-Facebook mobile ad network advertising allowing advertisers to target users while they're inside other people's apps
• Parse, the mobile app cloud development site

Not all of these will come good. But Facebook only needs two or three to be big hits, and that bolts on another $1 billion in revenue.

And all of that barely scratches the surface of Facebook's most valuable asset: The fact that it knows virtually everything about its users, in a way that other advertisers and market research firms simply do not.

The interesting thing is that most people - and most investors - have only just gotten up to speed on the current revenue products at Facebook. That's why I held onto my Facebook stock, and why I'm now glad that I did so. (Sure, I haven't made a fortune, but I've certainly made enough to buy a round of drinks while I toast all the haters who thought $31 was overpriced.)

The caveats: As a technical matter, Facebook is trading way above where it should be compared to average price-earnings ratios for S&P 500 stocks. So one obvious thing to say here is that if you bought Facebook in 2012, now is the time to sell. Perhaps I should too. But given that FB would have to lose about 36% of its value before I lose any money, I'm going to hold onto it for a while longer.

Disclosure: The author owns Facebook stock.