Facebook's Bull Run May Be Ending

Jun. 16, 2020 1:36 PM ETMeta Platforms, Inc. (META)72 Comments

Summary

  • Facebook's valuation appears to be stretched at current levels.
  • Analysts are betting that margins expand in 2021.
  • Options traders are betting the shares fall by the middle of July.
  • Looking for a helping hand in the market? Members of Reading The Markets get exclusive ideas and guidance to navigate any climate. Get started today »

Facebook's (FB) stock has run to all-time highs despite slowing growth, rising cost, and regulatory threats. Still, investors seem not to care, with the stock rising sharply since its March lows. Can shares of Facebook continue to increase despite these headwinds? It seems some traders are betting it doesn't, and begins to decline in the weeks ahead.

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Valuation Is High

The stock's move higher has resulted in shares trading at 23.8 times one-year forward earnings estimates. That is at the upper end of the stock's trading range over the past two years and above its average of 20.

(Refinitiv Datastream)

Analysts forecast that the company will see earnings grow to $7.27 per share in 2020 from $6.43 per share in 2019, which represents a growth rate of about 13%. But that is still lower than what the company earned in 2018, or $7.57 per share. Analysts then see earnings rising to $9.78 per share in 2021, a massive jump in growth, nearly 34.5%. The big question is if that growth in earnings is plausible, because revenue growth is expected to only be 24.5% in 2021, and is forecast to rise to around $77.5 billion. It means that most of the earnings growth for Facebook in 2021 will need to come from reduced cost and margin expansion.

However, operating margins for the company have been steadily declining and trending lower in recent quarters. It means that the company is going to need to see a sharp reversal in that trend for the company to be able to get the earnings power from the revenue being generated to hit analysts' projections.

(Refintiv)

Betting The Shares Fall

The outlook for the earnings growth and improving margins may be one reason some traders are betting against the stock rising further. On June 16, the open interest levels for the July 17 $230 calls rose by almost 8,000 contracts on June 16, while the open interest for the July 17 $230 puts rose by 7,600 puts. Interestingly, in this case, the calls traded on the bid and were sold for about $11.20 per contract, while the $230 puts were traded on ask, and were bought for around $10.10 per contract. Overall, this created a spread transaction, where the trader is betting that the value of Facebook declines, below $230, by the middle of July, from its current price of $236 on June 16.

Weakening Technicals

Additionally, the technical chart for Facebook is beginning to look bearish. It is currently forming a bearish divergence, with the relative strength index falling and the stock price trending sideways. This divergence is an indication that the trend in Facebook is likely beginning to shift from higher to lower.

Also, there is a minor possibility that the stock is forming a bearish pattern known as a double top. However, for this pattern to be confirmed, the stock would need to fall below support at $224. Should that happen, it could result in a steeper decline towards $203.

Finally, the equity has broken the long-term uptrend off the March the lows, and that also suggests that the shares push lower.

Risks

There are risks here because it is possible the purpose of the options trade was a protective hedge. Meaning, that an investor that owns the stock may be looking to protect their gains, and therefore is attempting to hedge the long position, using options. It makes it very hard to tell what the true intentions of trades in options are at points.

Facebook undoubtedly has made a powerful move off its March lows, and a mild pullback would undoubtedly be welcome news, as it would help to set up a longer-term march higher, as the company's fundamentals catch up to its stock price.

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This article was written by

Mott Capital Management profile picture
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Designed for investors looking for stock ideas and broader market trends.

I am Michael Kramer, the founder of Mott Capital Management and creator of Reading The Markets, an SA Marketplace service. I focus on macro themes and trends, look for long-term thematic growth investments, and use options data to find unusual activity.

I use my over 25 years of experience as a buy-side trader, analyst, and portfolio manager, to explain the twists and turns of the stock market and where it may be heading next. Additionally, I use data from top vendors to formulate my analysis, including sell-side analyst estimates and research, newsfeeds, in-depth options data, and gamma levels. 

Disclosure: I/we 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.

Additional disclosure: Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.

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