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Why analysts like Facebook ahead of earnings

Just 3 ½ years since its highly scrutinized initial public offering, Facebook is creeping toward a $300 billion valuation. The social media giant languished below its IPO price of $38 per share for more than a year, but has since enjoyed a fast and furious climb toward an elite club.

Read MoreFacebook could soon join a very elite club

The stock was trading around $103 on Tuesday, giving Facebook a market cap of $290 billion, hot on the heels of Amazon with a market cap of $293 billion. The only larger tech companies are Microsoft, which has a market cap of $432 billion, Alphabet with a market cap of $507 billion and Apple, which is valued at $687 billion.

Investors are so bullish on Facebook's prospects that the company's stock is trading at almost 20 times revenue — a price-to-sales multiple far above competitors like Apple, Amazon or Alphabet.

The company reports third-quarter 2015 results on Wednesday after the closing bell, and analysts expect revenue of $4.37 billion, up 36 percent year over year, and EPS of 52 cents, up from 43 cents per share a year earlier, according to Thomson Reuters.

"Facebook remains a powerhouse of growth and operating efficiency for investors, and is becoming increasingly important for more and more advertisers as one of online advertising's two hegemonic powers," wrote Pivotal Research analyst Brian Wieser in a note on Oct. 15. The other dominant force Wieser is referring to is, of course, Alphabet's Google.

Why do investors "like" Facebook so much, despite its rich valuation? The answer, in a word, is mobile. Ad revenue from mobile was 76 percent of total ad revenue in the second quarter, up 72 percent year over year.

Facebook and Facebook Messenger are the top two mobile apps in the U.S., in terms of reach, according to comScore. Even more impressive, comScore found smartphone users spend 50 percent of their time on their most-used app, and 80 percent of time on their top three apps.

In an note on Oct. 14, Argus Research upgraded the stock from "hold" to "buy" with a $115 price target and raised its 2015 EPS forecast by a penny to $2.04. "Facebook, with two of the most popular smartphone apps in the U.S., has successfully made the transition from desktop to mobile," wrote Argus analyst Joseph Bonner.

Although early in the process, analysts will be watching for any indication as to how Facebook's Instagram ad strategy is playing out. Instagram crossed 400 million monthly active users in the third quarter and more ads are appearing on the platform. Analysts expect Facebook to continue to increase monetization of Instagram in 2016 and, over time, of Messenger and WhatsApp.

"Anecdotally, we began seeing a ramp in our Instagram news feed in early August and we are now seeing multiple ads each day ranging from advertisers like Starwood, Coach, 7-Eleven and Go-Pro, among others," wrote Stifel analyst Scott Devitt in a note Friday. Devitt has a "buy" rating on the stock and a $108 price target.

"Importantly, we are seeing a variety of new advertising formats including carousel ads, video ads, app install ads and 'Sign Up' or 'Shop Now' ads, suggesting that Facebook has fully opened Instagram to Facebook's tools," he wrote.

Video ads will play automatically but silently, going fullscreen and adding sound when you tap or click.
Source: Facebook
Video ads will play automatically but silently, going fullscreen and adding sound when you tap or click.

In addition to Instagram monetization, analysts point to the strength of Facebook's video ad products as a key catalyst. The social media giant is trying to position itself as the obvious choice for advertisers shifting dollars from traditional TV to digital and mobile platforms. The company recently announced "Total Ratings Points" to allow advertisers to measure Instagram and Facebook video ads against similar traditional TV ad metrics. IAB notes that overall U.S. online advertising grew 23 percent year over year in the second quarter, the fastest growth rate since the second quarter of 2011.

"Facebook should also benefit from increasing popularity of video among advertisers and users. Recent product rollouts, such as autoplay video ads and carousel ads for Audience Network, should continue that positive momentum for the foreseeable future," wrote Wedbush analyst Michael Pachter in a note on Friday. Pachter expects Facebook to beat analyst estimates driven by average revenue per user expansion from video and mobile News Feed ads.

"We think management has rightly identified member-generated video as another opportunity to boost engagement," wrote Bonner. Engagement is something Facebook monitors extremely closely.

JMP Securities analyst Ronald V. Josey noted that, given more the more than 4 billion videos viewed daily, video consumption continues to drive engagement and could present a new opportunity for Facebook. "We'll be listening for any signs of a stand-alone video app launch and progress of its 360-degree video product," he wrote.

Messenger for Business screens
Source: Messenger

Josey reiterated his "market outperform" rating and $150 price target. He expects FB to report results that are better than consensus estimates and will also be watching for updates in several key areas: Facebook's Immersive Experience ads previewed in Cannes, France, and the "click-to-message" button for the company's 45 million active business pages, updates on the evolution of Messenger as an e-commerce platform, early results from Messenger's digital personal assistant "M," WhatsApp monetization, Oculus release dates, and key investments around ad tech and R&D head count.

Correction -- Because of a typo, and earlier version of this story misstated analysts' expectations for this quarter's revenue.