By James B Stewart
Over the last half decade, few stocks have been more beloved by investors and Wall Street analysts than Facebook. No wonder: After a rocky initial public offering in 2012, it has rolled over one obstacle after another, including the shift to mobile computing and the rise of photo sharing. It delivered revenue and user growth that surpassed even the most optimistic projections.
By the end of last year, Facebook had 2.2 billion active users. Its stock rose 53 per cent last year, single-handedly accounting for 3.7 per cent of the 21.8 per cent gain in the Standard & Poorâs 500 index, according to S&P Dow Jones Indices. By early February, its market capitalization had surpassed $ 560 billion, making it the fifth most valuable company in the index.
By then Facebook alone accounted for nearly 2 per cent of the S&P 500 index, which means that anyone who owns a broad-based stock mutual fund or index fund probably owns Facebook shares. Sophisticated investors and institutions, too, have considerable exposure: Goldman Sachs analysts reported last month that Facebook was the second most widely held stock (after Amazon) by hedge funds.
More than 90 per cent of Wall Street analysts covering the company deemed Facebook a âbuyâ in early February even though at $ 195 a share, its price-to-earnings ratio â a common valuation measure â was a lofty 35. (The average ratio now is about 24; historically, it has been about 15.)
It was, as Wall Street pundits like to say, âpriced for perfection.â
Whatever else can be said about Facebookâs recent tribulations, this much is certain: Its situation is far from perfection.
After revelations that data harvested from Facebook may have been used to try to influence Britainâs vote to leave the European Union and the United States presidential election, the social network giant faces multiple investigations in both Europe and the United States, along with potentially profit-crimping regulations and limits to its use of data. And investor retribution has been swift.
Since hitting its peak on Feb. 2, Facebook has lost an astonishing $ 100 billion in market capitalization. Its stock was trading midweek at close to $ 153 a share, a decline of nearly 22 per cent. (It rebounded by about 4.5 per cent Thursday and closed at $ 159.79.)
With Facebookâs plunge, investor concerns have spread to other social media and internet stocks with lofty multiples, like the so-called FANG stocks â Facebook, Apple and Amazon, Netflix and Google â and Twitter. They accounted for more than 10 per cent of the S&P 500 at their peak.
âPeople who own an index fund need to realize how important Facebook is, and how big a role it and the FANG stocks played in the marketâs rise,â said Howard Silverblatt, senior industry analyst for the S&P Dow Jones Indices, who oversees statistical analysis for the S&P 500. âThe FANG leadership is faltering. Social media hasnât faced much regulation, and now thereâs a cloud hanging over those companies.â
In the midst of past Facebook euphoria, few saw this coming. One that did was AIERA, a robot that uses artificial intelligence to make stock recommendations. AIERA, an acronym for artificially intelligent equity research analyst, put out a âsellâ recommendation for Facebook last fall.
So did Brian Wieser, a senior analyst at Pivotal Research Group who covers media and internet companies. Although he was positive about the stock for most of its long climb, he downgraded Facebook to âsellâ last summer based on regulatory and advertiser concerns and what he now considers âsystemic management issues.â
Not only was it a lonely position, but âthe stock went up and up,â Wieser told me this week. âBut I thought the market was wrong, full stop.â
âI didnât know what the catalyst would be, but at some point revenue growth had to slow and the margins go down,â he said. âThere are practical limits. And I felt investors were looking at Facebook in much too positive a light. They just ignored all the bad things, and there were a lot of them.â
Then, when the news broke this month that a British firm, Cambridge Analytica, had used Facebook data for voter profiling, Wieser said, he thought it was âthe most significant thing that had happened to Facebook since it became a public company.â
âMost people hadnât given much thought to how their data is used,â he added. âBut this really exposed the potential abuse. This is digital advertisingâs original sin, and thereâs going to be a reckoning that even now I donât think most investors fully appreciate.â
The other Facebook skeptic, AIERA, can talk, but Wells Fargo â whose global internet analyst, Ken Sena, developed the robot along with Bryan Healey â wasnât making its wunderkind available for interviews. But based on AIERAâs published comments, it issued its sell recommendation after analyzing the frequency of negative mentions in the media of Russiaâs use of Facebook to influence the presidential election, as well as fundamental valuation and technical factors. (AIERA uses artificial intelligence to read and analyze a half-million pieces of data per day gleaned from the internet. It currently analyzes more than 1,600 stocks.)
Wells Fargo has stressed that AIERA remains in experimental mode, but one potential advantage is that it removes all human emotion from its analysis. Thus, AIERA was indifferent to the fact that nearly every other analyst had a buy recommendation on Facebook.
That included her putative master, Sena, who was thrust into the somewhat awkward position of explaining his own buy recommendation even as AIERA said sell.
When I spoke to him this week, Sena stressed that AIERA was a tool that could detect patterns and eliminate bias.
âAIERA said election interference was a big deal, and it turned out it was a big deal,â Sena said. âBut itâs not meant to supplant human judgments.â
He hasnât changed his buy recommendation even though he agrees with Wieser that investors need to take threats of regulation seriously.
âThe conventional wisdom was that people donât care that much about how their data is used,â Sena said. âThey like the convenience of targeted advertising. But the level of public outcry over this is new.â
âFacebook is going to have to do a lot of explaining,â he added. âI believe they have the capability and the technology to make the platform secure. But itâs going to distract from other initiatives investors are counting on for growth, like virtual reality and video content.â
Even so, Facebookâs decline has been so steep that even Wieser and AIERA may reassess their recommendations if they calculate that the stock has bottomed out.
When he last reiterated his sell recommendation, Wieserâs price target was $ 152. âI donât want to be trigger happy on this,â he said. âItâs not clear yet what happens next. I want to fine-tune my thoughts before I revisit this.â
AIERA canceled her sell recommendation after the stock plunged. She hasnât yet made a new recommendation. Of 45 analysts who cover Facebook, 41 currently have a âbuyâ or âoverweightâ recommendation, up from 39 a month ago.
Sena is even more bullish on Facebook than he was before, and hasnât changed his price target of $ 230. âPeople are still glued to Facebook and Instagram,â he said.
Its price-to-earnings ratio is now just 28, barely above the market average, which makes it âthe cheapest stock in our coverage area, and it has some of the best growth prospects,â he said. âThereâs no way mathematically to justify a loss of more than $ 70 billion in market cap.â