Facebook emojis - an investor's field guide

Not only are these emojis readily available for use when interacting / expressing on Facebook's social media platform, I'm pretty sure they also represent the emotions we all feel as investors in the stock market. And perhaps ironically for Facebook (FB), you can probably place your emoji of choice at any spot along this year-to-date chart to reflect your feelings at the time.

Look, we're all still processing the quarter. But I'll share some initial thoughts ...

-Despite the drop in the stock, the business of FB is still very good. Top line growth of +42% Y/Y in the quarter was solid, MAUs grew (+11%) to >2.2B, and there remains a long runway of opportunity in capturing the secular growth of digital advertising (where higher prices and more dollars are flowing in droves, and should for many years).

-Think of it this way, this industry is compounding at a mid-teens pace and represents an enormous market opportunity. And in the midst of this the evidence suggests that advertisers continue to increase their planned spend on Facebook’s platforms as ROI dollar-for-dollar is better there than just about anywhere else. Bottom line, the social network still holds one of the world’s most valuable sets of data on people's interests, wants, desires, fears, aspirations, which can all be specifically and methodically targeted. Of course, this all makes that vast (yet highly specific) audience easily available and attractive to advertisers. The company remains in a dominant position, a duopoly really, in digital (and indeed mobile) advertising alongside Alphabet Inc.’s Google.

-The company’s guidance is probably what’s hurting the stock today. Revenues are excepted to go from +42% to the +35-38% range by Q418 (the horrors!). Meanwhile because FB is plowing a ton of cash flow back into their business to defend (i.e., widen their moat) and grow their business, operating margins may fall from mid-40s to mid-30s over the next two years. But Facebook CFO Wehner says they should then bottom. I think that management is being quite sensible about their industry and the growth we can expect. They are also being extremely candid regarding the amount of money required to get that growth. Nevertheless, this all took investors by surprise, and traders gonna trade.

-Facebook is notorious for being unapologetic when plowing capital back into their business at the expense of margins (which I actually like). Op margins were above 60% just a couple of years ago. Higher levels of investment took them into the 50s ... then 40s. All along the way the stock did very well. Now it seems we're heading another turn lower as they attempt to ramp their other properties including Instagram and Messenger, as well as invest in projects like “stories”, adding staff (including mass hiring for improving privacy and security), and invest in other really expensive but important things like AI.   

-That said, I also believe it's possible that management is being conservative here and are trying to lower the bar – rein in the runaway enthusiasm for growth embedded in the analyst community and re tune expectations for future quarters. As Gene Munster wrote this morning, “The company has a track record of resetting revenue growth and expense expectations only to turn around and exceed those expectations the following quarter.”

 -Between Facebook, video, stories, Instagram, Messenger, and What’s App, Facebook has a lot of levers to pull in growing their business – these are all 1B+ user platforms waiting to be fully monetized (I am already now beginning to see ads in Messenger) and ad loads across these apps seem to have significant headroom. Facebook (and Google) continue to eat the world in the digital and mobile ad business (between 55-70% of U.S. market share between the two) and have the resources to do it.

-Taken together, Facebook properties boast over 1/3rd of the entire world population. This is a “free” and sticky ecosystem with mountains of personal data highly valuable to folks trying to sell you stuff. And simply put the company is no longer trying to maximize sales and profits near-term to satisfy Wall Street targets as they had been doing for many years. Instead, management believes it will add value in the long-term by increasing investment spend and thinking more about important issues like privacy and getting user protection and trust right. This is perhaps the most crucial thing they need to accomplish in order to be viable.

-So what’s likely happening today is a resetting of expectations, and admittedly it can be painful over the short-run – there were a ton of momentum traders in the stock that are now fleeing and the ever prescient sell-side is now pilling on – but I think we need to remember that these changes are not exactly being forced upon the company, rather this is a function of decisions and long-term thinking that Facebook is making themselves to build their business and look to the future. The market opportunity and their role in it remains unchanged, in my opinion. Don’t forget, investors and the media crowed when Facebook bought Instagram for $1B dollars back in 2012, a business now likely valued north of $100B. And that's just one random example. Long. Term. Thinking.    

 -Many are conflating what happened in the spring with Cambridge Analytica and issues around privacy with today's guidance. Don't. This is not what Facebook is saying. They are two separate things. What's happening is that Facebook is attempting move its audience over to more engaging features (away from news feed to 'stories' similar to Instagram, for example). It's not a demand problem. People still login into Facebook properties; they're not leaving; and advertisers want to spend more money. This isn't a GDPR issue, and it isn't about data privacy. Good companies invest in their business. Good companies make changes for the better in service to the long-term. This is what Facebook is doing.

To wrap this up, my favorite thought of the day – across all the opinion, articles, and punditry I’ve seen – was what our head trader and CCO Mason Woolf said to me this morning when he and I sat down to talk Facebook and the stock. He said … “you know Jason, I read on Bloomberg this morning that this $120 billion loss in market cap for FB marks the largest ever loss of value in one day for a U.S. traded company. But I don’t think what the company is saying qualifies as the biggest calamity in corporate history. That doesn’t match up. I think the selling is likely overdone.”

I found that to be really great perspective. Simple. Logical. Impossible to disagree with. He nailed it. I mean come on ... what ... did the Russians suddenly take control of Facebook's entire server farm? Is Putin now CEO? How can this business, with its growth and opportunity, but with that guidance possibly result in the largest single-stock rout in market history? It's absurd. And that should tell you something.

Oh, I almost forgot ... about that YTD chart I shared at the beginning, here's the longer-term view from Eddy Elfenbein. Even with today’s drop the stock is now only back to where it was in mid-May, and is still ~$30 above where it traded to during the CA morass in the spring.

So we've come full circle, and when looking at Eddy's chart I suppose I must now winnow the field down to only two emojis that can best describe FB as a long-run investment - *hint they're the two expressions on the far left.* NYU's Scott Galloway says that Facebook has a "supernova business." I wonder, is there an emoji for that?

Jason L. Ware, MBA / Chief Investment Officer

?Of course, the caveat here is that there’s a fair chance that I am totally wrong on all of the above. The ice may now be melting right from under Facebook’s feet. And the stock may be overvalued against a reality that I simply don’t see. So like any of our investments, we will continue to monitor, examine, and think about our ownership in Facebook's business. This blog and its contents represent my opinion and sarcasm only - it does not reflect the opinions of Albion Financial Group. These musings should also not be confused for, or taken as, investment advice nor instruction / recommendation to buy or sell any security or investment discussed therein.