Is Facebook's Fall Indicative Of Risk Or Opportunity?

| About: Facebook (FB)


Facebook shares fell 4% last Wednesday, starting a stir that has continued into this week, while stocks in the S&P 500 and Dow Jones Indices performed relatively well.

However, Facebook was not alone in its decline, as its FANG peers and the broader Nasdaq index declined substantially.

Herein I attempt to explain why I believe the decline happened and provide guidance for FB holders about the future.

Facebook (Nasdaq: FB) shares declined by 4% last Wednesday and volatility and relative weakness have continued into this week. However, the stock has not been alone in its troubles, with FANG peers and the NASDAQ down in kind. In my view, there has been more than one catalyst behind it, though the factors involved were complementary.

Given that I see a significant positive offset in store for stocks broadly in corporate tax cuts, and for Facebook and its FANG peers pending some possible revision to the legislation, I would use any near-term weakness to add to holdings. Facebook remains long-term appealing while exploiting revenue leverage over its vast member base, and while valued inexpensively when comparing to expected growth.

Issue Is Not Company Specific

First, it's important to note that we know for sure there was not a company-specific factor in play against Facebook shares last Wednesday. That's because the Nasdaq fell as well (PowerShares QQQ (Nasdaq: QQQ) -1.7%), while FB's FANG peers were significantly lower too.

Shares 11-29-17
Facebook -4.0%
Amazon (NASDAQ:AMZN) -2.7%
Netflix (NASDAQ:NFLX) -5.5%
PowerShares QQQ (QQQ) -1.7%
SPDR S&P 500 (NYSEARCA:SPY) -0.05%

Table constructed by analyst/author

The catalysts appear to me to have been multiple, though related or complementary in nature.

First, we should note that the two most important representatives of the Federal Reserve, departing Chairlady Yellen and her replacement Jerome Powell, signaled significant hawkishness in high profile testimonies to congressional panels over the course of the days ahead of the move. Such a representation broadly threatens growth stocks with perceived expensive valuations, as the cost of capital to such firms rises under a faster tightening rate trajectory.

So, as a result, firms like Facebook could see their shares sold on an asset allocation shift to value plays and sector rotation in such a scenario. Though, I see emerging companies with high debt loads and little earnings more appropriately threatened in such a scenario, based on my experience as an analyst. Note, the Dow Jones Industrials (NYSE: DIA) was actually up about 0.5% Wednesday and the S&P 500 Index was about flat (SPDR S&P 500 -0.05%). Cyclicals, especially financial sector stocks, see benefits from rising interest rates and a steepening yield curve. The Financial Select Sector SPDR ETF (NYSE: XLF) was up 1.7% yesterday as a result of this same factor.

Incoming Fed Chair, pending confirmation, Jerome Powell said in his confirmation hearing before the Senate Banking Committee, "I think the case for raising interest rates at our next meeting is coming together." Of course, that's not surprising to the market, which has priced in its expectation (90.2% probability) for as much. It's next year's rate trajectory that is mismatched between the Fed's expectations and the market's, where the market sees just two hikes coming versus the Fed's dot-plot projection for about three.

Adding fuel to the fire, Fed Chair Yellen spoke strongly in her appearance before congressmen last week. She produced a headline-making statement that I believe played a significant role in repricing for popularly held securities with rich valuations and strong year-to-date performances available for profit-taking. Chair Yellen stated, "We don't want to cause a boom-bust condition in the economy," indicating market tempering rate hikes are probably in store for 2018.

There is also speculation that tax reform plan tweaking, or general progression, may lead to some unwanted taxation of internet companies like Facebook. Pressure seems to be increasing thanks to the budget repercussions of the tax plan, but to-date it seems Congress is seeking other ways to control costs. Later, we learned that specifics in the new legislation may penalize Facebook and some of its peers. It appears that after some pushback from investors and affected industries, the legislation may be tweaked for their benefit.

The relative pressure against these stocks cannot be relieved until the final legislation is prepared for vote and passed into law. I do not believe legislators would dare penalize America's leading edge industries while attempting to serve American industry and get companies to repatriate vast overseas cash stores, at least not yet. You'll want to keep a close eye on this risk, however, as I see it as perhaps the most important threat to FANG.

One other threat to FANG shares, up significantly year-to-date, is profit taking. Certainly, Goldman Sachs' statement on the subject did not help these shares. In any event, the relative value created in the stock by the selloff should attract new bidders, especially if the company benefits from tax reform legislation tweaking as I expect.

Facebook shares should recover after this temporary lapse sometime in early December, in my view, and probably on tax reform passage. Thus, I suggest buying into this weakness as the stocks should benefit significantly from the passage of the tax reform package (as long as they are not penalized by the details of the new law). Underlying global economic growth continues to benefit Facebook's advertising revenue streams longer term, and the business model here remains one of the best I've seen in years.

Valuation is a concern when considered in isolation (forward P/E of 30x), yes, but considering FB's growth outlook, with analysts' 5-year growth forecast consensus at 29% (data by Yahoo Finance via Thomson Reuters), the stock's valuation seems reasonable to me. This is especially true when considering the company's vast opportunity to leverage its massive member base for significant incremental revenue and earnings.

Applying its growth rate, and assuming the stock can maintain its current valuation one year forward, implies a 12-month price target of approximately $230. Facebook is a stock I've recommended for purchase since it traded in the $20s, only after its post-IPO decline, and I continue to favor the shares today. For more of my work on stocks and markets, readers are welcomed to follow the column here at Seeking Alpha.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FB over 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.

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