Facebook’s $120 Billion Debacle

The FAANG stocks, i.e., Facebook, Apple, Amazon, Netflix, and Google have been the Holy Grail for Wall Street investors for a very long time. Investors always expect these stocks to always go up in value.

The assumption is that the underlying business of these companies will continue to record growth in terms of users, revenues as well as profits every quarter. This is the reason that everyone wants to own the invincible FAANG stocks. Out of whack expectations have led to an out of whack valuation. Each of the FAANG stocks has a price to equity ratio above 30.

The aura of invincibility that the tech stocks had acquired took a massive beating of 26th July 2018. This is the day on which the Facebook stock took a massive beating. The stock collapsed more than 20% in value. This stock collapse happened very rapidly. As a result, $120 billion worth of market value was wiped out in just a couple of trading sessions.

In this article, we will have a closer look at some of the reasons behind this flash crash.

How Significant Is This Stock Price Drop?

The stock price drop seems to be a bit of an over-reaction from investors. It is true that the underlying business of the company has suffered a few blows. However, the loss has not been so significant that a 20% loss of valuation can be justified.

The drop in the value of Facebook shares has been more than the market capitalization of McDonald's! This is the most significant loss of market capitalization faced by any company in the history of Wall Street. However, Facebook is not really a stranger to steep price drops.

Facebook had faced a similar crash in April when the Cambridge Analytica scandal broke out. However, once the media hype was over, the shares started galloping once again. The strength of Facebook’s shares can be gauged from the fact that even after a 20% decline in value, the stock is still trading higher than it was in January 2018.

Reasons behind the Sudden Decline

The sharp decline in the valuation of the company can be associated with the following factors:

  • Slowing Growth: Facebook has business interests worldwide. However, the company earns most of its revenues from North America and Europe. This is the region where advertisers are willing to pay the maximum money. The problem is that Facebook has already penetrated these markets. There is not much scope for future growth. This is the reason why the company experienced muted growth in terms of users and revenues, this quarter.

    The management of Facebook has mentioned that this muted growth in key markets is likely to continue for some time. This has spooked out investors who have come to associate Facebook with “hypergrowth”. Some of these investors do not have realistic expectations. This is the reason why Facebook needs to indulge in expectation management exercises.

  • Privacy Laws: Europe has unveiled Global Data Protection and Regulation (GDPR) laws. These laws are considerably strict on information technology companies which make money by selling consumer data. This is the reason why Facebook has faced severe setbacks in this region.

    Consumer advocates have woken up to the importance of privacy. As a result, there are severe restrictions on the type of data that Facebook can collect and sell. Investors are viewing this as a loss of competitive advantage. This is the reason why they are hammering the Facebook stock.

  • Terrible Public Relations: After the Cambridge Analytica scandal, Facebook has faced a lot of flak because of its loose policies. It is sometimes touted to be an irresponsible organization.

    After the Cambridge Analytica scandal broke out, Facebook was forced to create stricter processes. It is now the job of Facebook to prevent the flow of fake news and misinformation on its social media platform. This has translated into higher expenses for the company. Investors are worried that these increased expenses are permanent in nature. This is another primary reason which led to the sudden decline in the price of the Facebook stock.

Effects of the Sudden Decline

Most financial analysts believe that the Facebook flash crash is nothing more than a blip. They believe that its impact is temporary at best and the underlying business of Facebook is unlikely to be affected. However, we have listed some important effects.

  • High Attrition: Facebook pays its employees a huge part of their compensation via stocks. Hence, the fall in the price of the stock means that the payouts will be smaller. If the employees start believing that the price of Facebook stock will not rise any further, then they may start abandoning the company. This temporary stock price crash may end up having a permanent impact on the business of this giant corporation.
  • Contagion Effect: Investors are also wary that a drop in Facebook’s price may also cause other FAANG stocks to drop in value. Till now, nothing of that sort has happened. The other stocks continue to hold their value despite the fall in Facebook’s value. However, if the other stocks start collapsing, the problem will be irreparable since FAANG stocks collectively represent a huge chunk of market capitalization.

To sum it up, Facebook’s stock price decline can be attributed to excessive investor expectations and bad publicity.

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