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Advertisers Are Willing to Pay More for Facebook Ads

Facebook (NASDAQ: FB) CFO Dave Wehner has been warning investors of an impending ad revenue growth slowdown for over a year now. During the first-quarter earnings call, he said: "We continue to expect that we'll see deceleration in ad revenue growth. And that's going to be particularly pronounced as we get into the second half of 2017."

Facebook's third-quarter earnings results didn't show much of a deceleration. In fact, ad revenue growth accelerated compared with the second quarter, going from 47% growth to 49%.

To be sure, Wehner warned that ad inventory growth will slow, and it did. Ad impressions increased just 10% year over year last quarter. But he may have underestimated the strength of Facebook's advertising products and marketers' demand for their strong performance relative to its peers.

Image source: Facebook

6 million advertisers

During the third-quarter earnings call, COO Sheryl Sandberg announced that Facebook recently surpassed 6 million active advertisers. The company added another 1 million advertisers in the past six months. Instagram's active advertiser count is growing rapidly as well.

Since Facebook's advertising platform relies on a bidding system, the more demand for Facebook ads, the higher the price per ad, all else being equal. With 1 million more advertisers in the third quarter than the first quarter, Facebook certainly saw strong demand growth. As a result, average price per ad increased 35% year over year.

All about return on investment

Advertisers have plenty of options for digital advertising besides Facebook. Snap (NYSE: SNAP) and Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google have increasingly engaged young audiences with Snapchat and YouTube, respectively. They each have also seen their average ad prices decline, possibly presenting some value. Twitter (NYSE: TWTR) is also seeing a decline in average ad price as it finds more ways to increase ad impressions. Nonetheless, advertisers are content to pay more for Facebook ads.

That's because Facebook has worked to develop better targeting tools and ad products that convert into sales. With the vast majority of its 6 million active advertisers small and medium-sized businesses buying direct-response advertisements, as opposed to branding advertisements, the ability to convert a user into a buyer is key. Facebook performs admirably in that regard.

In a recent survey from RBC Capital and AdAge, Facebook ads scored a 6.7 on a scale from 0 to 8 among marketers for return on investment. Only Google scored higher, at 7.0. Snapchat scored just 3.4 points.

Facebook separates itself from other social-media platforms with its superior ad products and targeting. Until the return on investment of Facebook ads moves closer to the ROI on other social advertisements, there's still room for Facebook's average ad prices to climb.

Still warning investors

Wehner changed his tone a bit on the third-quarter earnings call. "We also expect the growth in advertising revenue will increasingly be driven by price," he told analysts. That's a significant change from the warning that ad revenue growth would come down "meaningfully" in the second half of 2017.

That said, he's still warning investors. "We expect this trend to continue for the foreseeable future," he said of the year-over-year deceleration in ad revenue growth.

Facebook continues to add new advertisers, and the demand for its ad products are strong, which supports higher ad prices. While the company won't be able to exercise as much control over its ad growth, the most recent quarter indicates that Facebook still has at least another year of exceptionally strong ad revenue growth to come. But the gap between Facebook's ad return on investment and those of competing platforms indicates it'll be much longer before we see much of a slowdown.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, and Twitter. The Motley Fool has a disclosure policy.