We have been thinking a lot today about what Facebook’s 19% one-day drop means to markets and their valuation of disruptive technologies. After many conversations and lots of crossed-out items on a list, we came up with these three points:
#1. Even in widely followed names, markets can get things spectacularly wrong. Consider that Facebook closed the regular Wednesday trading session at an all-time high. Clearly, the traders who pushed it there had no clue what was about to happen. Credit Facebook finance staff and senior management for being able to keep a secret, if nothing else.
For research-driven investors like hedge funds and large long-only investors, Facebook’s miss will be a wake-up call on the need for better information. We can only imagine what today’s morning meetings were like for funds overweight FB into the quarter. You can be sure analysts will be scrambling to find new sources on the name and other Tech stocks in their portfolio.
One last point to consider: the smartest money tends to be the most voracious users of data-centric research inputs. This is the very sort of information that should have caught several parts of the Facebook’s fundamental slowdown early enough to be actionable. The record close just moments before the disappointing release shows either data-focused research missed this, or traders/investors simply overlooked it in favor of following the tape.
#2. While today’s blow-up recalls similar one-day declines from history, there is something profoundly different about Tech. Past stock disasters — think Philip Morris cutting cigarette prices by 20% in 1993 or Disney fretting over ESPN/cord-cutting in 2015 – centered on the competitive landscapes of companies with mature products and stable, well-understood business models. Price, quantity and margins were uncertain, but business model longevity never really entered the market discussion.
By contrast, Facebook is both a relatively new company and its competitive advantage stems from the network effect and user engagement of the platform. Both have proven powerful forces when it comes to profitability and equity market valuation, to be sure. But how comparable those are to established, branded consumer or media companies, we simply do not know yet.
#3. In the end, equity valuations for FANG stocks and other internet-enabled business models is a fundamentally new challenge for investors. At their core, they are ideas created by a handful of people, developed/maintained by perhaps 10,000 coders (and sometimes much less), but then used by billions around the world. This is a new phenomenon, and we suspect equity markets do not yet understand what “correct/normalized” valuations should be.
Nowhere is this more visible than the paradox of Tech stocks that trade for 20x earnings (or more) in a world where Moore’s Law still doubles computing power/dollar every 2 years. Over the next 10 years, that means computing power/dollar will increase 15 times over. Lofty Tech sector valuations assume today’s giants will continue to lead. Today’s drop in Facebook’s stock price reminds us how tenuous that confidence can be.