The Media Strikes Back Against Facebook

Facebook Continues Its Decline

Facebook stock was down 2.6% on Tuesday as the headlines about the Cambridge Analytica story swirled. I have a new perspective on the story which I don’t think others have covered. This situation is all about stakeholders in the company. Facebook will have an extremely tough time satisfying stakeholders because almost everyone has a Facebook account and millions of businesses have a presence on the social network with many paying to advertise their products. Facebook is a behemoth that answers to everyone. There is almost no other business like it. Facebook is like the government in that whatever it decides to do will hurt some stakeholders and help others.

Politics Is Hurting Facebook

Facebook is being attacked by politicians. Politicians are advertising clients, they use the website to share their thoughts on public policy (free posts), they are involved with what constitutes free speech on the network, and they can write laws to regulate it. Facebook is being blamed for the 2016 election because the winners used it effectively. I think it’s possible that the losing party will always criticize Facebook for not being fair, regardless of whether it acts objectively fair. This is just like how the moderators of debates get criticized for asking what some consider to be biased questions.

I don’t think Facebook will be able to easily host conversations on political topics and sell advertising on the platform to politicians and political websites without being regulated more. It’s a tough pill to swallow for the company because it has other content besides political posts. It doesn’t want to stop being a place where people can discuss politics because the company has already seen a weakening in original content creation. During the election season, this can be the most discussed topic on the network. It has introduced trending news to rival Twitter because Twitter has the edge on discussions about the latest information.

The Media Is Reveling In Facebook’s Controversy

The decrease in original sharing has forced Facebook to push up original posts on timelines and promote groups through the algorithm to get people posting more often. This shift hurt publishers who run Facebook pages. It’s extremely difficult to grow a Facebook page. Even if you have a Facebook page with millions of followers, it’s difficult to reach your followers without paying Facebook. Most publishers were miffed at Facebook because they think they’re entitled to reach their fans. Obviously, Facebook wants everyone to succeed, but the most important factor the network needs to improve is the time spent on the website. There’s no point in logging in if users only see articles their friends shared. You can read those articles on the websites they are hosted on.

Last year some publishers reported 20% or more declines in their reach on Facebook. Publishers are less interested in the platform as they have less steak in whether the company does well since the percentage of traffic coming from the website has diminished. I think media publishers are happy to see Facebook in trouble since Facebook recently cut their traffic. Articles about the demise of Facebook and how to delete your account are very popular and they hurt Facebook. Web publishers have an inherent interest in getting people off Facebook and back onto their websites. This motivation to hurt Facebook will continue unless Facebook changes its algorithm, which it won’t do because it needs original posts to keep people coming back.

Value Underperforming Since January 2017

As you can see from the chart below, growth stocks have outperformed value stocks since the beginning of last year. This is the MSCI World index, so it’s not just a U.S.-centric phenomenon. As you can see, the ratio has fallen to the lowest point in a few years even in the face of higher interest rates. Some are saying Facebook’s decline is a signal the growth trade will end. I wouldn’t go that far because this news is specific to Facebook. At most, this news signals the top tech stocks will be facing increased regulation. I’m not saying the growth trade won’t end, but I don’t think its end will be caused by Facebook or that Facebook is falling because the growth trade is ending.

Keep in mind, when you’re looking at value stocks, understand that stocks with high dividends might fall because bonds will offer more competition to their dividend yield. One of the worst group of stocks has been the consumer packaged goods industry. Stocks such as Kellogg’s, General Mills, Kraft Heinz, and Campbell Soup have been hurt because yields have risen and the consumer’s tastes have changed. Their stocks were at bubble levels in 2016 as they had very high multiples. Now they are back to normal. If the sell off gets over done as most trends do, they could become buys.

The chart below shows the MSCI world index versus the 12 month forward estimates. As you can see, the stock market has decoupled from earnings estimates just like it did in 2016. It took 2 months for the market to catch up to earnings in 2016. To be clear, I don’t think you can rely on earnings estimates when forecasting stock prices because they are often overly optimistic right before recessions. Recessions are rare, but they can run your portfolio if you get long right before one. Because I don’t think a global recession will occur in the next 12 months, I expect stocks to catch up to earnings again. This chart implies stocks will rebound very soon because they have been off the highs for 2 months. I am not that optimistic, but sometime in the next 6 months I expect another all-time high.

Conclusion

I think Facebook stock is now pricing in the risk which has always existed. This isn’t short term news as regulation will be coming which hurts profitability. Furthermore, the company will need to hire more employees to monitor each transaction to avoid another issue. More people have already been hired to review whether posts are offensive or illegal. The moderation team has been beefed up. These changes will lower margins in the long term.

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