It can be tough to go short stocks in a stock market that has been surging. However, it can occasionally be a wise move to have a few shorts, especially if you have a portfolio dominated by long positions. One stock that appears headed lower is Facebook (FB). Below are three reasons why investors should considering going short.
Reason #1 - Technicals
Let's start off by looking at a 3 month chart of Facebook.
As the chart shows, the recent 3 months have not been kind to Facebook investors. The stock has sold off roughly 16% during this period. At the same time lets compare Facebook's performance to the broader market, the tech sector, and Facebook's closest competitor.
To look at the broader market return, let's pull up a 3 month chart of the S&P Depository Receipts (SPY).
So while Facebook has had a massive decline, the broader market through SPY has returned approximately 5%.
Let's turn our focus to a more specific index and look at the ETF called Powershares QQQ (QQQ). This ETF tracks the broader technology sector. If we pull up a 3 month chart, we will once again see a strong performance, unlike Facebook.
So the technology sector through their ETF has returned approximately 3.3% during this same period. Now let's take it one step further and look at Facebook's closest social networking competitor in LinkedIn Corp. (LNKD).
LinkedIn is the stock that everyone uses as Facebook's closest competitor. Much like Facebook, Linked In focuses strictly on the social networking space but is geared towards business professionals looking to establish new relationships and expand career opportunities.
LinkedIn has not only outperformed Facebook in the past 3 months, it has been one of the hottest stocks anywhere, rising more than 45%.
In summary, Facebook has declined by over 16% during the previous 3 months, while the tech sector, the broader market, and LinkedIn have all shown strong appreciation. Besides Facebook's weak technical picture, let's look at the second reason to short, its fundamentals.
Reason #2 - Fundamentals
Although the technical picture presents a strong case for going short on Facebook, it's also important to look at the company's fundamentals in order to understand the complete picture.
During Facebook's last annual report, there were some key numbers that raised a lot of eyebrows. First, on the balance sheet, the company's long-term debt exploded. At the end of 2011, the company's long term debt was only $398 million. At the end of 2012, that had exploded to $1.99 billion. At the same time, the company's cash had only increased by $870 million from the end 2011.
Now if we turn our attention to the income statement, the future looks even darker. While Facebook's total revenue came in at $5.09 billion, up from $3.7 billion in 2011, the company generated a much smaller profit. In 2011, Facebook generated an operating income of $1.76 billion but in 2012 only generated an OI of $538 million, despite having higher revenue. Additionally, the company's net income for 2012 was only $32 million, down from $668 million in 2011.
So to summarize, Facebook generated more revenue in 2012 but had a smaller operating income, a smaller net income, and long-term debt that had more than tripled. It's no wonder that the company is resorting to gimmicks in attempt to generate more revenue, which brings us to the third reason to short Facebook.
Reason #3 - Revenue Gimmicks
Facebook has been trying to find ways to please wall street analysts and investors. In attempt to generate more revenue, the company has come up with 2 ways that it thinks will help.
The first way is to charge a $7 fee for users to be able to "promote and share" from one of their friend's status updates. Facebook says that there is demand for it and that it will benefit users, allowing friends to draw attention to good deeds, special achievements, milestones such as an anniversary or birth of a new child. While there may be demand for this service if its free, I can't envision very many people paying $7 to promote a status update of a friend.
The second way is to charge users $1 to send a message to people outside their immediate circle of friends. The problem is that users can always just send the person a friend request first to get around paying that $1 fee. Again, similar to the promotion/marketing $7 fee above, I can't see many users wanting to pay that.
Again, it is a little surprising that Facebook management couldn't find better, more creative ways to generate new revenue streams. Asking people to suddenly pay for something that they haven't had to in the past is tough sledding.
I don't see a lot of positives with Facebook right now but instead see a lot of negative trends that are causes for concern. The technical picture presents an ugly story and when combined with poor earnings and lack of creativity to grow revenue, presents an exciting short opportunity, especially when combined in a portfolio with other long positions.