Facebook Analyst Downgrades: Do We Care? Are Any Analysts Now Credible?

| About: Facebook (FB)

The Facebook (NASDAQ:FB) stock price fell by 5% on Friday to $18.06 on the back of two leading brokers cutting the valuations (as well as one expert reiterating the bull case) but the downgrades and notes make no sense and there is just no reason at all to pay any attention to anything Wall Street now publishes on this stock. Do not read into this that I am a bull trying to shrug off bad news. I have always been a mega bear on Facebook, starting off with a price target of $7.30 at the IPO and subsequently cutting that to $5 for reasons you can read here.

But the analysts as a whole are discredited. According to StreetInsider, 19 analysts rate this stock as a buy, 15 as a hold and 1 is a seller. Since the IPO, the only shift has been some folk moving from buy to hold (as the stock price has more than halved). In summary, following the advice of all bar one of the 35 analysts covering Facebook would have lost you a vast amount of money. And so why do we now pay attention to anything that they say?

The most bearish downgrade came from BDO Capital, which slashed its target price from $25 to $15 and reiterated its "underperform stance." It also cut its Q3 revenue estimates from $1.21 billion to $1.9 billion and said that many ad executives mentioned the word "pause" in relation to Facebook campaigns. This is interesting if a tad nonsensical.

The interest is the comment on the ad executives. Given the low returns they have received plus the various scandals about 'bot advertising, notably the Limited Run affair, their reluctance to commit their marketing budget to Facebook should come as no surprise. I predicted it a good while ago here but it seems that, at last, Wall Street is waking up to it. This should drive home the point here that there is no earnings visibility at all for Facebook (even on a six month view) and that means that all the long term DCF models on which analysts valuations are based are just worthless. I continue to maintain that this stock can only be valued on the basis of historic earnings, hence my $5 price target.

What I fail to understand is how an analyst can pare his revenue (and, I guess, therefore profits) forecasts but slash his price target by 40%. Surely a price target based on a DCF valuation must be derived from the forecast cashflows? As such trimming your numbers but slashing a price target does not equate. As ever, my suspicion is that too many analysts base a price target as much on where the stock sits currently as on what it is actually fundamentally worth.

But at least BDO is on the right track. Bank of America/Merrill Lynch (NYSE:BAC) is in a different place. It reiterated its "neutral" stance but cut its price target from $35 to $23. Why? Has it too revised its forecasts and arrived at the conclusion that the net present value of Facebook's future cash flows is now two thirds of what it thought it would be a few days ago? And why rate the stock as "neutral" at $18.06 with a $23 price target? Surely if BofA/Merrill really believes that there is 27.25% upside in this stock, it should be advising its clients to add to their holdings? That seems a pretty good return to me - for a liquid stock, I'd buy for that sort of gain. If I believed in it.

These downgrades will not be the last. Facebook followers can expect almost every one of the 35 Wall Street gurus to cut their target prices again, and again over the next six months. But this will not be driven by huge cuts to earnings forecasts or even by an acceptance that you simply cannot produce a DCF model for this stock, but simply as a reaction to the continuing slide in the underlying stock price. There will be accompanying (downward) tweaks to forecasts as the ad scandals make a clear impact on revenue growth but it will take some time for a more general acceptance that there is just no long-term earnings visibility for this company and that, as a result, all valuations based on DCF models are inherently useless. What surprises me is that given that 34 out of 35 experts have gotten this stock 100% wrong ever since it listed, why would anyone pay the slightest bit of attention to what they say now?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.