When it comes to investing, taking a skeptical view to consensus thinking, with an eye towards risk management is a good thing. It may help you to lose less (or even make money) when popular opinion shifts and stocks reverse course. Skepticism gives you the tools to move much faster once the fever breaks and crowded trades become unwound. There are numerous examples over the past year like Apple, Disney & Netflix, all down between 20 and 30% from their 52 week and all time highs, with sentiment shifts somewhat inconceivable without prior thought of the possibility of a turn.
On the flip side, being contrarian for contrarian’s sake is a sure-fire way to lose money. As an example, look at Facebook’s (FB) Q4 results given last night, and the stock’s nearly 13% gap higher this morning. That suggests that investors were caught off-sides and were selling FB with the assumption that its sentiment had shifted like the others (I was in that camp). Here was my take last Friday when considering a trade into FB’s print:
In my mind FB is priced for perfection, maybe not on the surface relative to growth, but very likely relative to generally accepted accounting principles or GAAP. For instance, consensus estimates are calling for a 33% year over year EPS gain for FB, making the stock’s 34 P/E look pretty reasonable for a company expected to grow sales 38% in 2016. But peel back a layer of the onion and use GAAP earnings and that adjusted EPS of $2.87 looks more like $1.81 and the PE looks a bit more like 54x. And I am not sure there has ever been a near $300 billion market cap company that has traded 11.5x expected sales, 16x trailing. Convince yourself of that you want about their PEG ratio (PE to Growth) but if you are using adjusted you are fooling yourself (read Barron’s here on the topic from last June).
So what’s the trade? Is the stock near term oversold? Probably. Could it bounce above $100 on a beat and raise? You bet ya, probably as high as $105, but I suspect we will see some profit taking as that would put the stock unchanged on the year and I am not sure the market we are in is ready for the re-emergence of FANG.
I was clearly wrong to be both contrarian and skeptical. I was a little right on the trade set up and the possible reaction of the stock. Where I was wrong had mostly to do with being contrarian for contrarian’s sake. The reasons I identify such as valuation for why the stock could be vulnerable to a decline will be in large part the reason why investor sentiment will ultimately shift, but that’s clearly not happening anytime soon. And the read through from FB’s management’s body language was that they see little trouble on the horizon.
Apple’s (AAPL) stock lost about $35 billion in market cap yesterday, largely the result of their weak forward guidance that is being impacted by a challenging global macro environment. FB, on the other hand, is set to gain about $30 billion in market cap this morning on a blowout report, and commentary that they do no “see anything in Q4 that indicated broad-based macro weakness“. Is this confusing? Not really. FB is in the midst of a mutli-year massive secular shift in the advertising business, with few competitors if any with their global reach and scale. This is the same sort of trend that AAPL benefited from in the latter part of the last decade to very recently with the introduction of the iPhone. That was at a time when smartphone penetration was very low, global wirless data 3g/4g networks were nascent and mobile apps and services didn’t even exist. The company rode a massive wave until competition caught up, and the market became saturated. Similar to what we may now be seeing with NFLX, as competition is their main concern.
Just because a company’s products are not you cup of tea (FB for me) or the valuation of the stock makes your stomach turn (FB trades more than 12x expected 2016 sales) and the story is universally loved , it’s not worth being contrarian, or even skeptical until their is a possibility of a turn in the story.
I would add that Amazon and Google could set up similarly to FB when they report tonight and Feb 1st respectively, as both may be insulated from the headwinds affecting near term growth for companies like Apple and Netflix.