In 2016 Q3, Facebook (Nasdaq: FB ) reported quarter over quarter and year over year growth in revenue, net income and earnings per share. Following the earnings release, Facebook's share price is now down over 8%. Some investors may believe the price drop is a buying opportunity (buy the dip); they should not. Even with Facebook's strong Q3 performance, I believe FB stock is overvalued and investors should stay away.

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In the analysis below I will discuss two operational headwinds that will cause Facebook's revenue and net income growth to stagnate in the future. The third paragraph will look at why earnings per share may actually decrease.

DAU and MAU Growth

Facebook defines DAU as daily active users and MAU as monthly active users. During the earnings release, the company shared the following graphics on the geographic composition on DAU and MAU growth.

(Click on image to enlarge)

(Click on image to enlarge)

I've listed down some points worth noting:

1. For US & Canada, Facebook's DAU and MAU have only increased by ~10% between Q3 '14 and Q3 '16.
2. In Europe, Facebook's DAU and MAU have increased by ~20% between Q3 '14 and Q3 '16.
3. The majority of Facebook's DAU and MAU growth in the past two years has come from Rest of World and Asia Pacific.

Facebook also shared its average revenue per user broken down by region.

(Click on image to enlarge)

The US & Canada region had the most profitable revenue per user ($15.65) while Rest of World ($1.21) and Asia-Pacific ($1.89) were significantly lower than the company average ($4.01). Facebook's growth in DAU and MAU is occurring in its least profitable markets: Rest of World and Asia-Pacific. The company's most profitable markets (US & Canada) had the lowest growth in DAU and MAU. Facebook is growing the fastest in its least profitable markets and growing the slowest in its most profitable market.

Until Facebook can monetize Rest of World better, the company's revenue growth will likely decline. Facebook's trailing twelve months earnings multiple is currently 45; twice the industry average and in my opinion very high for a company that is only growing in its least profitable markets.

Revenue Diversification

The Average Revenue Per User (ARU) graphic above shows revenue has two components: advertising, and payments & other fees. For all geographic locations, advertising accounted for over 90% of Facebook's total revenue. For the entire company, advertising generated 97% of total revenue. Facebook's reliance on advertising revenue creates two risks for investors.

First, CFO David Wehner stated that the company is reaching the limit on how many adverts can be displayed (ad-load) without negatively impacting user experience. If Facebook cannot find ways to show more ads on its platform, the company will have to rely on growth in DAU and MAU to increase revenue. As shown above, the only regions Facebook is growing DAUs and MAUs in, are the least profitable markets. The lack of substantial growth in its most profitable markets, coupled with a ceiling on the number of ads that can be shown may cause revenue growth to decrease.

Second, the company stated that better efforts to disable ad blockers resulted in an increase in desktop revenue. Facebook faces a constant back and forth with ad blockers to show ads on desktops. In Q3 2016, desktop revenue was $1.1 billion; ~17% of total revenue. Greater adoption of ad blockers or better ad blocking puts a large portion of Facebook's desktop revenue at risk.

A final topic (suspicion) worth discussing, for which, unfortunately, I have no data to prove, is that Facebook may be heavily reliant on startups for advertising. Mobile shopping app Wish is reportedly Facebook's #1 advertiser and is currently attempting to raise $500 million in venture capital. Many other ventures backed startups are likely also big spenders on Facebook ads. A slowdown in venture capital investing may cause some of these startups to reduce their spend on Facebook ads. 

FB Stock - Equity Dilution

Similar to many technology companies, Facebook is in a constant battle to retain the best technical talent. Stock options are the most common mechanism used to reward and retain employees in tech. Over the past five quarters, Facebook has diluted shareholders consistently quarter over quarter by issuing more common stock. Listing out Facebook's total outstanding shares over the last five quarters:

• Q3 2015: 2,826
• Q4 2015: 2,845
• Q1 2016: 2,860
• Q2 2016: 2,870
• Q3 2016: 2,882

Facebook's consistent dilution coupled with potentially stalling revenue growth may lead to a decline in earnings per share. A stock with declining EPS will likely not trade at a 45X earnings multiple as FB stock does today. Facebook's dilution is almost entirely due to stock option rewards to retain and reward employees and fund acquisitions. What happens when Facebook stock stops rising? Option rewards become useless. Top engineering talent can depart to smaller faster-growing firms like SnapChat (soon to IPO) or any of the numerous other well-funded startups.

Conclusion

In conclusion, I believe FB stock is currently overvalued. The company's only growth in DAU and MAU is in its least profitable markets. DAU and MAU are barely growing in the most profitable markets. The company states it can no longer show more adverts without impacting user experience. Revenue growth will have to come from usage growth but users are only growing in the least profitable markets. Additionally, the company keeps issuing more shares which dilutes existing shareholders. Facebook may experience significantly slower growth in the future than it has in the past, potentially dragging earnings growth, and with it, Facebook stock.