• Facebook's growth rate is ultimately tied to growth in digital ad expenditures.
• Digital ads have grown at more than 15 percent annually in recent years, and there's reason to believe growth will continue.
• Given Facebook's huge share of digital ads, there exists a strong case for sustainable returns over the long term.

Of all the FAANG stocks, I've always thought that Facebook (FB) offered the best prospects for sustainable returns over the long term. At this stage, the company bears no resemblance to the riskier bet of eight years ago. Today's Facebook is a cash machine with a huge moat around its business.

To estimate Facebook's future growth, it's necessary to look at the digital advertising space as a whole. Here, I review the projected growth of the global advertising industry and run a few thought experiments based on Facebook's expected share of ad expenditures. The results show that Facebook stock is actually a lot cheaper than its earnings multiple would suggest.

Digital Advertising Growth

With social media usage surging during the pandemic, it doesn't appear that Facebook's engagement is going away anytime soon. The core Facebook site grew its monthly active user base to 2.7 billion people last quarter, representing 19 percent in less than two years. While FactSet expected daily active users on the site to fall to 1.7 billion, DAUs actually increased to 1.79 billion. The company estimates that 2.5 billion people use at least one of its services every day.

At the end of the day, Facebook's revenue growth is tied to the growth of the advertising industry, specifically digital advertising. Although global advertising will decrease 7.2 percent worldwide in 2020 due to the pandemic recession, digital advertising is expected to grow modestly in the low single digits to approximately $333 billion, according to eMarketer. Internet advertising is continuing to gobble up market share as traditional non-digital advertising declines. This year, digital will surpass 60 percent of the total advertising market.

With ad revenue of $75 billion, Facebook holds around 22 percent of the global digital ad market, a duopoly it shares with Google (GOOG). Analysts often point out that Facebook cannot keep growing sales at a 23 percent CAGR, as the company has managed to do over the last three years. If that happened, Facebook would soon eclipse the size of the entire advertising market, which is obviously impossible.

Yet, the latest reports estimate the digital advertising will grow to $640 billion by 2027, a CAGR of 10.3 percent. And as Ark Invest analyst James Wang observed two years ago, projections have consistently underestimated digital ad growth. In 2014, eMarketer forecasted a $188 billion market for digital ads in 2017, but actual digital ad spent exceeded $232 billion.