What Facebook's Fall Tells Us About Investors Today

Last update on Aug. 6, 2018.

Image Credit:  tongcom photographer / Shutterstock.com

 

At the beginning of every month, I brief members on how MoneyGeek's Regular portfolios have performed and comment on the state of the financial markets. In this update, I’ll also discuss Facebook’s stock.

 

July Performance of Regular Portfolios

The performance of MoneyGeek's Regular portfolios for the month of July 2018 were as follows:

 

Last Month

Last 12 Months

Since Apr 2013

Aggressive

+1.3%

+15.3%

+103.8%

Growth

+1.1%

+13.4%

+85.9%

Balanced

+1.0%

+11.5%

+69.1%

Conservative

+0.8%

+9.7%

+53.7%

Very Conservative

+0.7%

+7.8%

+39.3%

I've chosen to list below the performance of some of our competitors. For the sake of brevity, I've decided to show only those portfolios that have a similar risk profile to MoneyGeek's Regular Aggressive portfolio.

 

Last Month

Last 12 Months

Since Apr 2013

RBC Select Aggressive Growth

+1.5%

+10.2%

+42.7%

TD Comfort Aggressive Growth

+2.0%

+9.2%

+49.7%

CIBC Managed Aggressive Growth

+0.9%

+12.1%

+52.0%

Canadian Couch Potato Aggressive

+1.3%

+11.0%

N/A

In contrast with our competitors, MoneyGeek’s Regular portfolios employ stocks/ETFs that follow the value investing strategy (QVAL, IVAL and BRK-B), and also allocate a larger percentage of the portfolios toward Canadian oil and gas stocks (XEG.TO) and gold (CGL-C.TO). If you would like to take a look at our portfolios, I invite you to sign up for our free membership.

In July, Regular portfolios performed about as well as our competitors. BRK-B soared by 5% as the company announced plans to buy back its shares more aggressively than it has in the past. However, gold prices continued to drag down the portfolio.

It seems nearly impossible to faze the US stock market investor. There are a number of ongoing developments that could cause a recession, but chief on economists’ minds is the escalating trade war with China. The Trump administration is apparently considering increasing tariffs on Chinese goods, and Chinese stocks have been falling hard in response. However, US stocks continued to notch solid gains through all the bad news.

Even among US stocks, one particular set of stocks appeared to be almost impervious to any bad news: the “FAANG” (Facebook, Apple, Amazon, Netflix and Google) stocks. Over the past 5 years, these 5 stocks essentially tripled, while the rest of the US stocks, on average, gained less than 40%.

Investors seems to have adopted the mentality that no price is too high to buy one of these stocks. They believe (probably correctly) that the FAANG companies are great businesses led by very capable leaders, and so they’ve reasoned that these companies will grow their earnings practically forever.

Unfortunately, such sentiment is but a manifestation of some common psychological biases, such as the availability heuristic (a mental shortcut where we make decisions based simply on what evidence is most recent, readily available, or easiest to come to mind, rather than looking at the entire picture). In reality, humans have a poor record of forecasting the future because it’s hard to imagine all the events that can affect a company.

One such unforeseen scenario that occurred for Facebook is the Cambridge Analytica scandal. As you may already know, Facebook had sold private data on millions of its users to Cambridge Analytica, who used the data in order to influence voters. A public outcry ensued, and Facebook promised to guard its private data more closely.

Another unforeseen scenario that affected Facebook is the implementation of General Data Protection Regulation (GDPR), a European law designed to protect the privacy of its citizens. The law places more restrictions on the way Facebook can collect and sell its data.

Privacy rules can heavily influence Facebook’s business model. Most of Facebook’s revenues come from selling ads, and the efficacy of those ads depends on how well they can target users for those ads. But Facebook can only target users well if they obtain and share as much user information as they can. If the new privacy rules prevent them from collecting such information, the ads will lose their efficacy and advertisers will go elsewhere.

A few people warned about the implications of the new privacy rules early on. Facebook’s own CFO warned that its business would suffer, though you could argue he didn’t paint as gloomy a picture as he could have. Some analysts on Seeking Alpha gave good arguments as to why GDPR would be a big deal for Facebook. But such warnings fell on the deaf ears of investors, who pushed Facebook’s stock price up by more than 20% from the beginning of May (after the Facebook CFO’s warning) to late July - right before Facebook announced earnings.

Then, on July 25, Facebook announced its earnings. Although it earned more than analysts had forecast, it recorded slightly lower revenue than expected. More importantly, the company said it expected to earn less during the rest of the year than it had initially thought, due to the more stringent privacy rules. Facebook’s shareholders were seemingly caught off guard as the stock plunged by 19% the next day.

This incident revealed a couple of things about the average Facebook investor. First, it appears that many investors don’t do their due diligence on their stock. While individual investors could perhaps be forgiven for this sin, it’s surprising to me that institutional investors, with their army of researchers, chose to ignore obvious warning signs about Facebook’s business.

Second, it seems that growth is everything for high flying stocks like Facebook. Investors will pay any amount of money to own a fast growing stock. On the other hand, when the growth story appears to be coming to an end, investors will sell their stock off very quickly.

Given that it’s very hard to foresee what the future will look like for any stock, I believe it’s wise to stay away from stocks like Facebook that are expensively priced, and that rely very heavily on maintaining growth. MoneyGeek’s portfolios generally shy away from such stocks already, and I will try to keep it that way.

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